[Federal Register Volume 63, Number 13 (Wednesday, January 21, 1998)]
[Rules and Regulations]
[Pages 3214-3238]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-1395]



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Part III





Department of Housing and Urban Development





_______________________________________________________________________



24 CFR Part 3500



Amendments to Real Estate Settlement Procedures Act Regulation 
(Regulation X)--Escrow Accounting Procedures; Final Rule

  Federal Register / Vol. 63, No. 13 / Wednesday, January 21, 1998 / 
Rules and Regulations  

[[Page 3214]]



DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR-4079-F-02]
RIN 2502-AG75


Amendments to Real Estate Settlement Procedures Act Regulation 
(Regulation X)--Escrow Accounting Procedures

AGENCY: Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner, HUD.

ACTION: Final rule.

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SUMMARY: In this final rule, the Department of Housing and Urban 
Development is revising Regulation X, which implements the Real Estate 
Settlement Procedures Act of 1974 (RESPA). This rule addresses problems 
that were raised in applying escrow accounting requirements under 
Regulation X. The first problem, designated as ``Annual vs. Installment 
Disbursements,'' involves whether disbursements from mortgage escrow 
accounts must be made on an annual or installment basis when the payee 
offers a choice. To address this problem, this rule maintains the 
current requirements under Regulation X, but clarifies them.
    The second problem, designated as ``Payment Shock,'' involves the 
proper accounting method to calculate escrow payments where the 
servicer anticipates that disbursements for items such as property 
taxes will increase substantially in the second year of the escrow 
account and where ``payment shock''--the consumer's experiencing of a 
substantial rise in escrow payments--will result. The Department has 
chosen to address this matter by recommending (but not mandating) a 
best practice for servicers: a voluntary agreement to accept 
overpayments. A consumer disclosure format has been provided to 
disclose this information. This rule contains a new provision covering 
procedures for voluntary overpayments.
    The Department has determined not to adopt two other changes that 
were proposed. The Department will continue to require the single-item 
listing of escrow deposits on the HUD-1 or HUD-1A. Also, the Department 
is not revising the requirements for listing a lead-based paint 
inspection or risk assessment on the Good Faith Estimate (GFE) format 
and HUD-1 and HUD-1A, but is clarifying the instructions for these 
formats.

EFFECTIVE DATE: February 20, 1998.

FOR FURTHER INFORMATION CONTACT: David R. Williamson, Director, Office 
of Consumer and Regulatory Affairs, Room 9146, or Rebecca J. Holtz, 
Director, RESPA/ILS Division, telephone (202) 708-4560; or, for legal 
questions, Kenneth A. Markison, Assistant General Counsel for GSE/
RESPA, Room 9262, telephone (202) 708-1550, or Grant Mitchell, Senior 
Attorney for RESPA, telephone (202) 708-1552 (these are not toll-free 
telephone numbers). For hearing-and speech-impaired persons, these 
telephone numbers may be accessed via TTY (text telephone) by calling 
the Federal Information Relay Service at (800) 877-8339 (toll-free). 
The address for these persons is: Department of Housing and Urban 
Development, 451 Seventh Street, SW, Washington, DC 20410-0500.

SUPPLEMENTARY INFORMATION:

I. Background

    The Department's 1994-1995 escrow accounting rules 1 
included significant new requirements for servicers maintaining an 
estimated 35 million mortgage escrow accounts for American homeowners. 
These rules, promulgated under the Real Estate Settlement Procedures 
Act (RESPA) (12 U.S.C. 2601-2617), as amendments to Regulation X (24 
CFR part 3500), limited the amounts that servicers may hold in escrow 
accounts by establishing new uniform accounting and disbursement 
requirements and by requiring meaningful disclosure to each homeowner 
at the account's inception and annually thereafter.
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    \1\ The Department issued several escrow rules during 1994-1995. 
On October 26, 1994 (59 FR 53890), the Department published a final 
rule implementing sections 6(g) and 10 of RESPA and changes to RESPA 
made in section 942 of the Cranston-Gonzalez National Affordable 
Housing Act (Pub. L. 101-625, approved November 28, 1990). Because 
of the magnitude of the change brought about by this rule, soon 
after its publication it became evident that further clarification 
of the rule was needed. The Department issued a February 15, 1995 
rule (60 FR 8812) that modified and clarified the October 1994 rule 
and delayed its effective date until May 24, 1995. The Department 
issued further rules to clarify and correct the October 1994 rule on 
December 19, 1994 (50 FR 65442); March 1, 1995 (60 FR 11194); and 
May 9, 1995 (60 FR 24734), and published a notice of software 
availability on April 4, 1995 (60 FR 16985). These rules are 
referred to in this preamble collectively as the 1994-1995 escrow 
rules.
    The Department's RESPA regulations were streamlined on March 26, 
1996 (61 FR 13232) to comply with the President's regulatory reform 
initiatives. On September 3, 1996 (61 FR 46510), the Department 
published a correction to 24 CFR 3500.17. The Department published 
further revisions to Regulation X on September 24, 1996 (61 FR 
50208) and November 15, 1996 (61 FR 58472).
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    The 1994-1995 escrow rules represented a notable achievement. As a 
result of the escrow rules, the amounts in homeowners' escrow accounts 
have been reduced substantially. At the time the rules were 
promulgated, the Department estimated that homeowners would save as 
much as $1.5 billion by virtue of the new rules. This savings is now 
being used by homeowners for down payments, to keep and maintain homes, 
or to fill other needs.
    Because the 1994-1995 escrow rules implemented new accounting 
requirements, they required major changes by mortgage servicers. As the 
rule's requirements were applied to individual accounts, members of 
Congress, local government officials, industry representatives, and 
homeowners brought to the Department's attention certain problems 
concerning the 1994-1995 rules. In this final rule, the Department is 
clarifying the rules and identifying ``best practices'' 2 of 
mortgage servicers in an effort to resolve two of these problems.
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    \2\ Generally, the Department has characterized ``best 
practices'' in other programs as those practices that are in 
accordance with a law's purposes, that are widely replicable, that 
show creativity in addressing a problem or problems, and that have a 
significant positive impact on those whom they are intended to 
serve. The Department identifies best practices operating 
successfully in the marketplace that support the regulatory 
principles involved in order to encourage their use. For example, 
the Department has identified best practices in furtherance of its 
responsibilities under the Fair Housing Act (42 U.S.C. 3601 et 
seq.).
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    As detailed below, the first problem, designated as ``Annual vs. 
Installment Disbursements,'' is whether disbursements from mortgage 
escrow accounts should be made on an annual or installment basis if the 
payee offers a choice. In some cases, a switch from installment to 
annual disbursements, required under certain circumstances under the 
rule, resulted in servicers requiring greater payments to escrow 
accounts for some borrowers and adverse tax consequences for some 
borrowers. The second problem, designated as ``Payment Shock,'' was 
asserted to occur when borrowers were required to make significantly 
increased payments into their escrow accounts when disbursements for 
items such as property taxes would increase substantially in the second 
year of the escrow account and the rule did not allow servicers to 
require escrowing for the next year's payments. The Department also 
became aware of two additional concerns involving the disclosure of 
amounts required for escrow using single-item accounting and involving 
the possible need for a new disclosure of lead-based paint inspection 
fees.
    All of these matters led the Department to issue a proposed rule on 
September 3, 1996 (61 FR 46511) to seek public comment on these issues. 
In the

[[Page 3215]]

proposed rule, the Department offered a variety of approaches to 
address these matters in the most economical and efficient way. The 
Department recognized that the rules were new and industry and consumer 
adjustments were underway. Consequently, the choices included keeping 
the requirements the same, but clarifying them, or doing nothing.
    In the Department's proposal, the Secretary pointed out that any 
amendments to the rule must further the following three principles:
    (1) Reduce the cost of homeownership by ensuring that funds are not 
held in escrow accounts in excess of the amounts that are necessary to 
pay expenses for the mortgaged property and allowed by law;
    (2) Establish reasonable, uniform practices for escrow accounting; 
and
    (3) Provide servicers with clear, specific guidance on the 
requirements of section 10 of the Real Estate Settlement Procedures Act 
of 1974 (RESPA), which governs escrow accounting procedures.
    Following receipt of comments under the proposed rule, as detailed 
below, the Department determined that many of the initial problems in 
implementing the escrow rules were being resolved as the industry and 
the public adjusted to the new requirements. Specifically with respect 
to the choice of annual vs. installment disbursements, consumers' 
accounts that had been changed as a result of the implementation of the 
rule had stabilized and had not been changed again. However, there 
remains a need for the Department to clarify and elucidate current 
requirements in this final rule.
    With regard to the ``payment shock'' problem, the Department 
determined, based on the comments, that extensive additional regulatory 
changes are not required and could prove detrimental to consumers. 
Instead, the Department determined that this problem would be better 
resolved by identifying and sharing best practices of servicers. In 
this context, servicers should, as a best practice, provide a simple 
notice to consumers to allow them voluntarily to increase their 
payments to their accounts. A new provision in 24 CFR 
3500.17(f)(2)(iii) sets forth procedures if voluntary overpayment 
agreements are obtained.
    The Department also determined not to adopt other changes to the 
Good Faith Estimate (GFE), HUD-1, and HUD-1A that were proposed to 
address the other matters raised in the proposed rule. Based on the 
comments received, the Department determined that new requirements on 
these subjects were not necessary. Current disclosure requirements are 
generally useful and sufficient; more significant changes at this time 
could serve to confuse matters while the market is still adjusting to 
the relatively new rules. Moreover, the Department has recently issued 
a new settlement booklet for consumers entitled ``Buying Your Home, 
Settlement Costs and Helpful Information,'' published on June 11, 1997 
(62 FR 31982), which includes guidance on lead inspections during the 
homebuying process. To complement these new materials, the Department 
is making one minor clarification to the instructions for the HUD-1 
regarding lead-based paint disclosures.
    In sum, the regulatory record, described in detail below, makes 
very clear that this subject involves complex matters that in many 
cases are better resolved by allowing time for accounting systems and 
consumers alike to adjust. In this final rule, the Department continues 
to protect homeowners by maintaining escrow accounting requirements and 
limits without change. At the same time, in the interest of reducing 
homeownership costs, establishing uniform practices, and providing 
clear specific guidance, the rule makes modest clarifications to ensure 
that servicers do not unnecessarily incur additional costs that would 
ultimately be passed on to American homeowners.
    In applying the significant protections under RESPA--including the 
limits on the amounts in mortgage escrow accounts--the Department is 
mindful that it must carry out RESPA's important requirements in a 
manner that is true to RESPA's consumer protection purposes. These 
purposes include ensuring that consumers are protected from 
unnecessarily high costs that may come from abusive practices by 
servicers.
    This preamble continues with a background discussion of the legal 
requirements under section 10 of RESPA and the Department's prior 
rulemakings. Following the background discussion, the preamble 
discusses the issues addressed in the proposed rule and details the 
many comments received on the proposed rule. These comments informed 
the Department and shaped today's rule. Finally, the preamble discusses 
this final rule.

II. Legal Context

    Section 10 of RESPA (12 U.S.C. 2609) establishes the statutory 
limits on the amounts that mortgage servicers or lenders may require a 
borrower to deposit into an escrow account if the mortgage documents 
require one or the servicer chooses to establish one.3 RESPA 
does not require the use of escrow accounts. Section 10(a)(1) of RESPA 
does prohibit a servicer, at the time the escrow account is created, 
from requiring the borrower to make a payment to the escrow account in 
excess of the maximum amounts calculated in accordance with the 
statute. These maximum amounts are calculated by analyzing how much 
money will be needed to cover expected disbursements, such as taxes and 
insurance, ``beginning on the last date on which each such charge would 
have been paid under the normal lending practice of the lender and 
local custom, provided that the selection of each such date constitutes 
prudent lending practice, and ending on the due date of the first full 
installment payment under the mortgage'' relating to the mortgaged 
property, plus a cushion no greater than one-sixth of the estimated 
total annual disbursements from the account (one-sixth cushion). 
Section 10(a)(2) prohibits the lender, over the rest of the life of the 
escrow account, from requiring the borrower to make payments to the 
escrow account that exceed one-twelfth of the total annual escrow 
disbursements that the lender reasonably anticipates paying from the 
escrow account during the year, plus the amount necessary to maintain a 
one-sixth cushion. Section 10 does not require that the servicer 
collect the maximums allowed under the statute; the servicer may always 
collect less and is not required to collect any cushion at all.
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    \3\ As stated in footnote 1 to the preamble to the Department's 
September 3, 1996 proposed rule on escrow accounting (61 FR 46511, 
46511 n.1), at times RESPA uses the term ``lender'' and at other 
times it uses the term ``servicer.'' A lender creates a loan 
obligation, but may or may not service the loan. As in the proposed 
rule, within this final rule the Department uses the term 
``servicer'' to include the lender when the lender performs the 
servicing function.
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    Section 10 and section 6(g) of RESPA (12 U.S.C. 2605(g)) govern the 
timing of disbursements from escrow accounts. In choosing a 
disbursement date, section 10 requires that the servicer follow 
``normal lending practices of the lender and local custom, provided 
that the selection of each such date constitutes prudent lending 
practice.'' Section 6(g) requires servicers to ``make payments from the 
escrow account for such taxes, insurance premiums, and other charges in 
a timely manner as such payments become due.''

[[Page 3216]]

III. Explanation of Problems Addressed in September 3, 1996 
Proposed Rule and Proposed Solutions

    On September 3, 1996 (61 FR 46511), the Department published a 
proposed rule, primarily to address three problems in implementing the 
1994-1995 escrow rules. These problems, explained below, were 
designated as:
     Annual vs. Installment Disbursements;
     Payment Shock; and
     Single-item Analysis with Aggregate Adjustment.
    In addition, the Department proposed revising the GFE format and 
HUD-1 and HUD-1A to refer specifically to a lead-based paint inspection 
or risk assessment.

A. Annual vs. Installment Disbursements Problem

1. Explanation of the Annual vs. Installment Disbursements Problem
    The first problem that the proposed rule addressed involved the 
servicers' disbursements from mortgage escrow accounts if the payee 
(i.e., the entity to which escrow disbursements are paid, such as a 
taxing jurisdiction) offers a choice of disbursements on an annual or 
installment basis. Sometimes payees offer a discount to the borrower if 
disbursements are made on an annual basis. These discounts are commonly 
offered by taxing jurisdictions, which may offer a discount for annual 
payments of property taxes.
    The Department's regulation at 24 CFR 3500.17(k)(1) has provided, 
``In calculating the disbursement date, the servicer shall use a date 
on or before the earlier of the deadline to take advantage of 
discounts, if available, or the deadline to avoid a penalty.'' See also 
Secs. 3500.17(b) (definition of ``disbursement date''); 3500.17(c)(2) 
and (c)(3); and 3500.17(d)(1)(i)(A) and (2)(i)(A). The preamble to the 
October 1994 final rule explained, ``Unless there is a discount to the 
borrower for early payments, the regulation does not allow servicers to 
pay installment payments on an annual or other prepayment basis.'' 59 
FR 53893. The preamble explained that this approach is consistent with 
the Department's intention that the regulations generally favor 
installment disbursements, because in many cases they result in lower 
up-front payments (closing costs). The Department also sought for 
servicers to take advantage of discounts that would benefit borrowers.
    In response to further questions on this issue, however, the 
Department indicated in its February 1995 final rule clarifying the 
escrow rules that the October 1994 rule's focus had been to address ``a 
practice, previously engaged in by some servicers, of collecting and 
paying a full-year's taxes in advance, although they were billed on an 
installment basis.'' 59 FR 8813. In the preamble to a May 1995 further 
clarification to the rules, the Department stated that ``servicers were 
permitted (but not required) to make disbursements on an annual basis 
if a discount were available.'' The preamble to the May 1995 rule 
explained:

    [T]he Department received a number of questions regarding 
circumstances in which the payee offered an option of either 
installment payments or a one-time payment with a discount. The 
preamble to the October 26, 1994, and February 15, 1995, rules 
indicated that when a choice was available, servicers should make 
disbursements on an installment basis, rather than an annual basis; 
however, servicers were permitted (but not required) to make 
disbursements on an annual basis if a discount were available. Once 
the choice of payment basis is made, the disbursement date chosen 
for that basis depends on discount and penalty dates. Section 
3500.17(k) states that ``[i]n calculating the disbursement date, the 
servicer shall use a date on or before the earlier of the deadline 
to take advantage of discounts, if available, or the deadline to 
avoid a penalty.'' This provision is consistent with the rule, which 
is designed to avoid excessive upfront payments and balances in 
escrow accounts and, therefore, favors installment payments, unless 
there are penalties or discounts that make annual payments 
advantageous for the consumer. Also, after settlement a servicer and 
borrower are not prevented by this rule from mutually agreeing, on 
an individual case basis, to a different payment basis (installment 
or annual) or disbursement date.

60 FR 24734.
    In the preamble to the September 3, 1996 proposed rule, the 
Department indicated that the rule text and the preamble language may 
have created confusion. As explained in the preamble to the proposed 
rule, some mortgage servicers have interpreted the rule to require that 
a servicer, when offered an option of making a disbursement from the 
escrow account in installments or in an annual disbursement with a 
discount, must choose the lump sum annual disbursement with a discount, 
no matter how small the discount is, even if the borrower and the 
servicer would otherwise agree to forego the discount and have the 
escrow account computed for disbursements on an installment basis. On 
the other hand, other servicers have interpreted the Department's rule, 
in light of preamble language, to require installments when available 
and allow, but not require, annual disbursement at the servicer's 
discretion when a discount is offered for annual disbursement.
    As indicated in the preamble to the proposed rule, some borrowers 
were affected by the changes brought about by the 1994-1995 escrow 
rules. Concerns raised to the Department regarding the annual vs. 
installment disbursements problem came from borrowers and members of 
Congress who were concerned about the effect of the 1994-1995 escrow 
rules on their constituents.
    As explained in the preamble to the proposed rule, the choice of 
disbursement methods has consequences for borrowers, including 
increasing or decreasing the amounts required to be deposited into the 
escrow account at closing. In general, disbursements from an escrow 
account in installments work to the borrower's benefit, because, on 
average, they result in lower up-front payments to establish the 
account (i.e., lower closing costs). Footnote 2 of the proposed rule 
(61 FR 46512) explained:

    The choice of installment, rather than annual, disbursements 
often results in substantial reductions in up-front cash 
requirements for the buyer. For example, if two equal installments 
could be paid 6 months apart instead of paying the entire bill on 
one of the installment dates, then homebuyers who close on their 
loans less than 6 months before the date on which the entire bill 
would otherwise have been due could come to settlement with 6 months 
less in tax deposits to the escrow account. This results from the 
accrued taxes being a half-year's taxes less for those homebuyers. 
Assuming closings are evenly distributed throughout the year, 
households with the option of two equal installment payments 6 
months apart, will, on average, be able to reduce the average up-
front cash required at settlement by 3-months' worth of taxes. In 
general, as the number of installments grows, so does the average 
up-front savings.

The disbursement method may also have income tax ramifications for the 
consumer, depending on the timing of disbursements for deductible 
items.
    The preamble to the proposed rule explained that after publication 
of the 1994-1995 escrow rules, many servicers that had been disbursing 
in installments switched to annual disbursements if discounts were 
available. There were many consequences of the switch that have been 
described to the Department, mostly affecting borrowers, and other 
consequences that the Department speculates may have resulted. After 
the Department issued the escrow rule, some borrowers may have been 
required by their servicers to make up substantial shortages in their 
escrow accounts (generally in increased monthly payments over a year), 
which arose

[[Page 3217]]

when taxes were switched from installment disbursements to one annual 
lump sum disbursement.
    The preamble to the proposed rule also noted other adverse 
consequences that might have arisen from the 1994-1995 escrow rules. 
For example, some borrowers whose servicers switched from annual to 
installment disbursements may have lost a significant portion of their 
income tax deductions for property taxes in the year in which the 
switch was made and may have been unhappy with that consequence. Some 
taxing jurisdictions may have faced an unexpected temporary shortfall 
in receipts of property taxes as a result of servicers changing from 
annual to installment disbursements.
    The preamble to the proposed rule also noted that although some 
borrowers may have been adversely affected by a change in disbursement 
method, many others likely benefited, perhaps unknowingly, from such a 
change. For example, a change from installment to annual disbursements 
to take advantage of a discount lowered the total tax burden for many 
homeowners. Similarly, a change from annual to installment 
disbursements resulted in lower escrow payments and, possibly, refunds 
or credits for many homeowners. Finally, for many borrowers, the 
Department's rules apparently have not resulted in any change to the 
disbursement method for their escrow accounts.
2. Alternatives Proposed to Address Annual vs. Installment 
Disbursements Problem
    In response to the Annual vs. Installment Disbursements problem, 
the Department proposed alternative ways of revising the escrow rules, 
including requiring that disclosures be given to borrowers so that they 
could make informed choices as to how their accounts were to be set up 
and maintained and require servicers to follow those preferences. At 
the same time, the Department recognized that providing borrowers 
choices may impose additional burdens and costs on servicers, which are 
frequently passed on to borrowers. Thus, the proposed rule also 
highlighted approaches that had been proposed by industry 
representatives. The Department sought comments on all approaches and 
also asked a number of questions that were designed to help the 
Department make decisions among alternatives for the final rule.
    a. Consumer Choice. The first alternative contained in the proposed 
rule, Consumer Choice, distinguished between new loans and existing 
loans. Under this alternative, for new loans (loans that settled on or 
after the effective date of a final rule), servicers would be required 
to give borrowers the choice of making disbursements of property taxes 
on an installment or on an annual basis, when those options are offered 
by the taxing jurisdiction. The Department's proposal did not address 
the choice between installments and annual disbursements for other 
escrow items, because the question has only been raised to the 
Department in the context of property taxes. The preamble indicated 
that the Department would consider addressing other escrow items, 
depending on comments received.4
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    \4\ The preamble to the proposed rule noted that if the servicer 
is given a choice between installment or annual disbursements for 
other escrow items (such as property or hazard insurance), the 
Department's rule would require the servicer to make disbursements 
by a date that avoids a penalty, but the servicer would otherwise be 
free to make disbursements on such date as complies with normal 
lending practice of the lender and local custom, provided that the 
selection of each such date constitutes prudent lending practice.
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    This alternative would have required servicers, at some time before 
settlement, to provide a disclosure, in the format of Appendix F in the 
proposed rule, to borrowers whose property taxes will be paid from an 
escrow account and whose taxing jurisdictions offer the choice between 
disbursements on an installment or an annual basis. The proposed format 
indicated some of the advantages and disadvantages to the borrower of 
installment and annual disbursements and asked the borrower to make a 
choice between the methods. The preamble explained that if the borrower 
did not make a choice, the servicer would be required to make 
installment disbursements of property taxes. As discussed below, this 
alternative also would have provided that once the consumer had made a 
choice (or installments were required because the consumer did not make 
a choice), the servicer and subsequent servicers would be prohibited 
from changing the method of disbursement for property taxes without the 
borrower's prior written consent, as long as the taxing jurisdiction 
continued to offer a choice.
    For existing loans (loans that were settled prior to the effective 
date of a final rule), this alternative would have prohibited the 
servicer and subsequent servicers from changing the method of 
disbursement for property taxes without the borrower's prior written 
consent where the taxing jurisdiction offers a choice between 
installments and annual disbursements. In addition, no later than the 
first escrow analysis for such escrow accounts performed after the 
effective date of a final rule, servicers would be required to offer 
borrowers, in writing, an opportunity to switch from one method of 
disbursement for property taxes to another.
    b. Servicer Flexibility. Under the second alternative presented in 
the proposed rule, the Department would have revised the rule to 
provide that a servicer must make disbursements by a date that avoids a 
penalty, but the servicer is otherwise free to make disbursements on 
such date as complies with normal lending practice of the lender and 
local custom, provided that the selection of each such date constitutes 
prudent lending practice. As discussed below, under this alternative, 
once the servicer had made a choice of the disbursement method, the 
servicer and subsequent servicers would have been prohibited from 
changing the method of disbursement without the borrower's prior 
written consent, as long as the payee continued to offer a choice.
    c. Keep, But Clarify, Current Requirements. The third alternative 
offered in the proposed rule was that the Department would revise the 
rule to keep, but clarify the current requirements. Under this 
alternative, the regulations would have been revised to provide that 
servicers must make disbursements from escrow accounts on an 
installment basis, if payees offer that option as an alternative to 
annual disbursements. If a payee offers the option of installment 
disbursements or a discount for annual disbursements, however, the 
servicer may, at the servicer's discretion (but is not required by 
RESPA to), make annual disbursements, in order to take advantage of the 
discount for the borrower; the Department encourages (but does not 
require) servicers to follow the preference of the borrower. If the 
payee offers the option of installment disbursements or annual 
disbursements with no discount, the servicer must make installment 
disbursements.
    d. Prohibition Against Switching Disbursement Methods Without 
Borrower's Consent. Each of the alternatives proposed--Consumer Choice; 
Servicer Flexibility; and Keep, But Clarify, Current Requirements--
provided that once a disbursement method has been selected in 
accordance with the requirements of the alternative, servicers would be 
prohibited from switching disbursement methods without the borrower's 
consent. This would mean that even if one servicer acquires servicing 
from another servicer, the second servicer would be required to apply 
the same disbursement method as the first servicer, as long as that

[[Page 3218]]

option is offered by the payee, unless the borrower consents to 
changing disbursement methods.
    The preamble to the proposed rule explained that the reason for 
this approach was that many loans shifted disbursement dates as a 
result of the 1994-1995 escrow rules. The Department was seeking to 
develop an approach with the minimum negative impact for borrowers, 
servicers, and third parties, such as taxing jurisdictions.
    The preamble to the proposed rule explained the adverse 
consequences, discussed above, that can occur when borrowers' 
disbursement methods are switched. The preamble to the proposed rule 
explained that the approach of prohibiting a servicer from switching 
disbursement methods without the borrower's consent, including 
requiring a servicer to use the disbursement method used by the former 
servicer when there is a transfer of servicing, would not mean that the 
borrower would have to consent to a transfer of servicing or would have 
veto authority over such a transfer. However, this approach would mean 
that a borrower would have to consent to a change in the disbursement 
method, including a change proposed by a subsequent servicer. The 
Department sought comments on whether this policy would adversely 
affect the value, and the efficiency of the transfer, of servicing 
rights.

B. Payment Shock Problem

1. Explanation of Payment Shock Problem
    The second problem that the proposed rule addressed involved cases 
in which the originator or servicer 5 anticipates that 
disbursements for escrow items such as property taxes will increase 
substantially in the second year of the escrow account. A substantial 
increase in property taxes in the second year often occurs in cases of 
new construction. In many jurisdictions, the taxes the locality charges 
for the first year are based on the assessed value of the unimproved 
property, while for the second year the taxes are based on the improved 
value. A substantial increase in payments may also occur when a tax 
disbursement that would normally appear on the projection for the 
coming year is paid prior to the borrower's first regular payment, 
i.e., these regularly occurring taxes do not appear in the projection. 
Reassessments after a property is sold may also cause a substantial 
second year increase.
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    \5\ Three originators/servicers criticized the Department's 
proposed rule because it identified the ``servicer'' as the person 
who would be in a position to determine whether the bills paid out 
of the escrow account will increase substantially after the first 
year. These commenters indicated that it is the originator (loan 
officer, processor, settlement agent) who communicates with 
borrowers prior to closing, not the servicer, and that it should be 
the originators who would be in the position of determining at 
closing whether payments will substantially increase, not the 
servicer. The Department intended to use the terms interchangeably 
and explained in footnote 1 of the proposed rule (61 FR 46511) that 
the term ``servicer'' included the lender when the lender performs 
the servicing functions. The Department intended that the term 
``servicer'' also would include the originator in this context.
---------------------------------------------------------------------------

    The preamble to the proposed rule explained that, consistent with 
section 10 of RESPA, the Department's regulations have specified the 
maximum amount that a servicer may legally require borrowers to deposit 
in escrow accounts at the creation of the escrow account and during the 
life of the escrow account. The Department's regulations prescribe that 
in conducting an escrow account analysis, the servicer considers only 
the disbursements that are expected to come due during the next 12-
month period. See Secs. 3500.17(b) (definition of ``escrow account 
computation year'') and 3500.17(c) (limits on payments to escrow 
accounts). While the servicer can take into account expected changes to 
disbursements over the 12-month period,6 even if the 
servicer knows that disbursements from an escrow account will 
substantially increase at a time more than 12 months in the future, the 
servicer cannot, when preparing the initial escrow account statement, 
calculate the borrower's payments to cover the expected increases 
beyond that 12-month period.
---------------------------------------------------------------------------

    \6\ The preamble to the proposed rule (61 FR 46511, 46516 n.7) 
explained that the Department's current regulations address the 
issue of estimating disbursement amounts for the 12-month 
computation year:
    To conduct an escrow account analysis, the servicer shall 
estimate the amount of escrow account items to be disbursed. If the 
servicer knows the charge for an escrow item in the next computation 
year, then the servicer shall use that amount in estimating 
disbursement amounts. If the charge is unknown to the servicer, the 
servicer may base the estimate on the preceding year's charge as 
modified by an amount not exceeding the most recent year's change in 
the national Consumer Price Index for all urban consumers (CPI, all 
items). In cases of unassessed new construction, the servicer may 
base an estimate on the assessment of comparable residential 
property in the market area.
    24 CFR 3500.17(c)(7).
---------------------------------------------------------------------------

    However, the Department's existing regulations 
(Sec. 3500.17(f)(1)(ii)) allow the servicer to conduct escrow account 
analyses at other times during the escrow computation year, which can 
result in changes to what the borrower must deposit in the escrow 
account. Some servicers conduct escrow account analyses when bills for 
escrow items increase.
    Since the Department's current escrow rule provides for calculating 
escrow payments based on the projection of escrow disbursements for a 
12-month period, when escrow items increase substantially after the 
initial 12-month period, the result is likely to be a substantial 
increase in a borrower's monthly payments for the second year and/or a 
lump sum payment, not only to reflect the higher disbursements, but to 
make up a shortage in the escrow account.7 While the 
originator or servicer could alert the borrower at closing that an 
increase will occur, if that is not done, the borrower may be 
unpleasantly surprised by the increase. The preamble to the proposed 
rule explained that this situation could result in several problems. 
While disclosures received at closing show low payment amounts 
throughout the first year, the escrow payment will substantially 
increase for the second year, or even during the first year if a short-
year statement is issued at the point when the higher disbursement 
shows up in the 12-month projection.8 Some borrowers may be 
unable to meet the increased escrow payments and paying off the 
shortage will raise payments even more. A customer relations issue may 
be created for servicers who have to explain to borrowers why the 
payment is increased so much.
---------------------------------------------------------------------------

    \7\ The preamble to the proposed rule explained that an increase 
in the monthly payment can be broken down into two components. Any 
time an escrow account disbursement increases, it will have the 
effect of raising the monthly borrower escrow payment by 
approximately one-twelfth of that increase. In addition, the 
projection for the coming year shows what the target balance 
(accruals plus the cushion) should be at the beginning of the coming 
year. To the extent that expected disbursements in the second year 
exceed what they were in the first, the beginning target balance for 
the second year may be in excess of the actual balance at the end of 
the first year. If so, then there is a shortage to be made up as 
well. If the 12-month approach is taken to eliminate the shortage, 
then monthly payments will also rise by approximately one-twelfth of 
the shortage. If a cushion is used, the payment increases will be 
slightly higher, until the cushion is built up.
    \8\ The Department's regulations at 24 CFR 3500.17(f)(1) (i) and 
(ii) provide that, aside from conducting an escrow account analysis 
when an escrow account is established and at completion of the 
escrow account computation year, a servicer may conduct an escrow 
account analysis at other times. The escrow account analyses 
conducted at other times result in short-year statements.
---------------------------------------------------------------------------

    As indicated in the preamble to the proposed rule, the concerns 
raised to the Department regarding payment shock came largely from 
industry representatives who told the Department that they have had to 
respond to numerous borrower inquiries

[[Page 3219]]

and complaints about increases in escrow payments to reflect higher 
disbursements and payments to make up shortages. Mortgage servicers had 
indicated that they wanted to avoid any payment change in subsequent 
years by collecting more money in the first year of servicing.
2. Alternatives Proposed to Address Payment Shock Problem
    The proposed rule offered three rulemaking alternatives, some of 
which contained variations within the alternative, to address the 
payment shock problem. The purpose of the alternatives was to develop a 
consumer-friendly way to avoid the payment shock surprise for the 
borrower, who may not be prepared to make the higher payments to his or 
her escrow account that would result from a substantial increase in the 
amounts needed for disbursements from the account. At the same time, 
the proposals sought to minimize the burden on the industry.
     a. Consumer Choice. The first alternative contained in the 
proposed rule, Consumer Choice, would have provided that when the 
servicer expected that the bills disbursed from the escrow account 
would increase substantially after the first year, the servicer would 
provide to the borrower, at some time prior to closing, a written 
disclosure. The proposed format for the disclosure was set forth in 
Appendix G to the proposed rule. The borrower would make a choice from 
several accounting options for his or her account on a format that 
would indicate, under each option: (1) the amount due at closing; (2) 
the monthly escrow payments in the first, second, and third years; and 
(3) the corresponding surpluses anticipated at the end of the first 
year.9
---------------------------------------------------------------------------

    \9\ The preamble to the proposed rule noted that whether 
disbursements from escrow accounts would be made on an annual or 
installment basis and whether there were a discount for annual 
disbursement would affect the numbers to be filled in and, 
potentially, the number of calculations on the Escrow Accounting 
Method Selection Format.
---------------------------------------------------------------------------

    The proposed rule explained that the borrower would, therefore, 
have the opportunity to make a voluntary choice to limit payment 
changes in the second year of the escrow account. As would be explained 
on the disclosure format, if the borrower did not make a choice, the 
accounting method would ``default'' to the method prescribed under the 
current regulations (which may result in substantially increased 
payments in the second year). This alternative, as proposed, contained 
the additional restriction that once an escrow accounting method was 
selected by choice or default, that method could not be changed without 
the consent of the borrower, even if the servicing rights were 
transferred to another servicer.
    The preamble to the proposed rule explained that, under this 
alternative, the following accounting methods (illustrated in ``The 
Payment Shock Problem,'' Appendix H-1 to the proposed rule) would be 
presented to the borrower for his or her selection:
    Method A. Analysis of the account using the accounting method 
required under the current rule, which results in a shortage at the end 
of the first year and higher payments in the second year.
    Method B. Analysis of the account using an accounting method that:

--Requires an initial deposit of $0 into the escrow account at closing;
--Requires a monthly payment in the first year equal to one-twelfth of 
the estimated total annual disbursements from the escrow account for 
the second year; and
--Causes surpluses or smaller shortages at the end of the first year, 
which causes escrow payments to increase in the second year by an 
amount less than under Method A or not at all.

    Method C. Analysis of the account using an alternative accounting 
method that:

--Requires an initial deposit into the escrow account at closing 
greater than the initial deposits required under Method B;
--Requires the same monthly payment during the first year as under 
Method B, which is greater than under Method A;
--Generates month-end balances such that the lowest month-end balance 
for the first year equals one-sixth of the estimated total annual 
disbursements for the second year (the initial deposit is not 
considered in finding the lowest month-end balance);
--Generates even larger balances at the end of the first year than 
under Method B, eliminating shortages and increasing surpluses that 
must be returned to the borrower; and
--Causes no increase in escrow payments in the second year.

    The preamble to the proposed rule noted that if the consumer were 
to select Methods B or C, the amounts held in escrow could be greater 
than allowed under section 10 of RESPA. In order to permit these 
options, the Secretary would invoke his exemption authority under 
section 19(a) of RESPA (12 U.S.C. 2617).
    b. Make No Change. The second alternative in the proposed rule was 
to continue the current requirements for escrow analysis, even when the 
servicer expected that the bills disbursed from the escrow account 
would increase substantially after the first year. This alternative 
would not prevent payment shock in all instances. However, under this 
alternative, servicers could continue to disclose voluntarily the 
problem to borrowers and borrowers could make voluntary overpayments to 
escrow accounts. Servicers could also calculate short-year statements. 
Thus, even if no change were made to the regulations, some methods 
would continue to be available, although not required, to alleviate the 
payment shock problem.
    c. Mandate First Year Overpayment. Under the third alternative in 
the proposed rule, Mandate First Year Overpayment, the Department would 
have provided that when the servicer expected that the bills disbursed 
from the escrow account would increase substantially after the first 
year, the servicer would be required to establish the escrow account 
under a procedure that had the characteristics described under Consumer 
Choice, Method C, above (illustrated in ``The Payment Shock Problem,'' 
Appendix H-2 to the proposed rule). The preamble to the proposed rule 
explained that this approach would result in requiring amounts held in 
escrow to be greater than allowed under section 10 of RESPA. The 
Secretary could, however, mandate the use of this escrow accounting 
method pursuant to his exemption authority under section 19(a) of RESPA 
(12 U.S.C. 2617).

C. Single-Item Analysis With Aggregate Adjustment Problem

1. Explanation of Single-Item Analysis With Aggregate Adjustment 
Problem
    A third problem that the proposed rule addressed was the means of 
disclosure on the HUD-1 and HUD-1A settlement forms of amounts required 
for deposit at settlement in the escrow account. The 1994-1995 escrow 
rules established aggregate accounting (i.e., analyzing the escrow 
account as a whole) as the uniform nationwide standard escrow 
accounting method to be used to compute borrowers' escrow accounts. In 
establishing this standard, the rules supplanted single-item 
accounting, the accounting method that had been used at settlement up 
until that time to compute required escrow account balances. 
Historically, under single-item accounting, the reserve amount for each 
escrow account item on the HUD-1 or HUD-1A in the 1000 series was 
computed for the borrower and listed separately. Either zero, one, or 
two months worth of payments for

[[Page 3220]]

each escrow item was set forth on the HUD-1 or HUD-1A in the 1000 
series as necessary to establish the escrow account.
    When the Department was developing the 1994-1995 escrow rules, 
Federal Reserve Board staff indicated that even if aggregate accounting 
were used it also needed a single-item amount for private mortgage 
insurance (PMI) reserves in order to make annual percentage rate (APR) 
calculations under the Truth in Lending Act (TILA). For this reason, 
and in an effort to avoid altering the basic format of the HUD-1 or 
HUD-1A in the 1994-1995 escrow rules, the Department required that an 
aggregate adjustment (either zero or a negative number) be made after 
all of the individual items were listed separately in the 1000 series, 
so that the total amount for escrow account items conformed to the 
aggregate accounting method. Before the 1994-1995 escrow rules, Section 
L of the HUD-1 and HUD-1A only showed positive numbers, that is, 
payments that were being allocated to various settlement costs. After 
publication of the 1994-1995 escrow rules, the Department received 
complaints that the itemization of the reserve amounts with an 
aggregate adjustment was confusing and the information was not useful 
to borrowers. Settlement agents and others indicated that individual 
itemization of reserves in the 1000 series imposed an additional 
paperwork and explanation burden, when the only relevant number for 
calculations is the total deposited.
2. Revision Proposed to Address Single-Item Analysis With Aggregate 
Adjustment Problem
    In response to the Single-Item Analysis with Aggregate Adjustment 
problem the Department proposed to make more flexible the requirements 
for the provision of information to consumers. In the proposed rule, 
the Department proposed that to relieve confusion it would no longer 
require the single-item listing of escrow deposits or reserves on the 
HUD-1 or HUD-1A. The rule would create a new option in the instructions 
for the 1000 series of these forms to reflect the aggregate amounts to 
be deposited. As proposed, the settlement agent could also have 
continued to itemize the 1000-series reserves, at the settlement 
agent's discretion. If the charges were not itemized, an asterisk (*) 
would have had to be placed next to each item in the 1000 series for 
which a reserve was taken. The amount collected would have been 
described as ``Aggregate Escrow Deposit for Items Marked (*) Above'' on 
a line at the end of the 1000 series. In the discussion 
``Clarifications of Existing Rule'' in Part VI of the preamble to the 
proposed rule, the Department had clarified that entries on the GFE may 
be based on single-item analysis, with a maximum 1-month cushion. The 
proposed rule also clarified that the use of the estimating method 
remained available after the end of the phase-in period (October 24, 
1997).

D. Lead-Based Paint Disclosure Issue

1. Explanation of Lead-Based Paint Disclosure Issue
    The proposed rule also addressed a concern that consumers should 
get information about their right to arrange for a timely paint 
inspection or risk assessment for the presence of lead-based paint or 
lead-based paint hazards before becoming obligated under a sales 
contract. The preamble to the proposed rule explained that a 
prospective purchaser generally has 10 days to conduct such a lead-
based paint evaluation of the property. A prospective purchaser, 
however, may waive in writing the opportunity to conduct this 
evaluation. The proposed rule addressed ways that consumers could 
receive this information in addition to existing disclosure 
requirements.
2. Revision Proposed to Address Lead-Based Paint Disclosure Issue
    In response to the Lead-based Paint Disclosure issue, the 
Department proposed to require additional information to be provided to 
the consumer on the GFE and the HUD-1 or HUD-1A. The Department 
proposed to add information to the GFE format to help make purchasers 
of pre-1978 residential dwellings aware that, pursuant to 42 U.S.C. 
4852d (implemented by the Department in regulations published on March 
6, 1996, 61 FR 9064), purchasers have the right to arrange for a paint 
inspection or risk assessment for the presence of lead-based paint or 
lead-based paint hazards before becoming obligated under a sales 
contract. The Department proposed to add language to the GFE format 
(Appendix C to part 3500) specifically to refer to a lead-based paint 
inspection or risk assessment and designate a separate line in the 1300 
series of the HUD-1 and HUD-1A for lead-based paint inspections or 
assessments and to revise the instructions for completing the HUD-1 and 
HUD-1A accordingly. The preamble to the proposed rule indicated that 
the Department anticipated that a more detailed explanation of 
purchasers' rights in this regard would be contained in the next 
revision of the HUD Settlement Costs booklet. See section 5 of RESPA 
(12 U.S.C. 2604); 24 CFR 3500.6.

IV. Overview of Public Comments

A. Description of the Commenters

    The Department received a total of 141 comments on the proposed 
rule. Of the 141 comments, some were duplicates. Thus, the Department 
places the number of different comments received at 134.10 
The Department analyzed all the comments in detail and gave them 
careful consideration.
---------------------------------------------------------------------------

    \10\ Seven comments were identical letters submitted by various 
officials of the same mortgage corporation; they were counted as one 
comment. Two other comments were substantially similar letters 
submitted by different offices of the same bank and mortgage lending 
subsidiary; they also were counted as one comment, but minor 
variations between the two were considered.
    Twenty-one comments were duplicate comments submitted by various 
originators and servicers, including the United States Department of 
Agriculture. One bank and trust submitted nearly identical comments 
as the Mortgage Bankers of America (MBA), while the Oregon Bankers 
Association submitted nearly identical comments as the American 
Bankers Association (ABA). The Mortgage Bankers Association of 
Minnesota adopted with one small addition the comments of Norwest. 
Since these comments were submitted by separate entities, they are 
all counted as separate comments.
    One commenter simply summarized the proposed rule without taking 
a position on any of the proposals.
---------------------------------------------------------------------------

    One-hundred two of the comments came from originators/
servicers.11 Fourteen comments came from trade associations. 
Four came from individual consumers, three from tax service providers, 
two from members of Congress, four from financial software companies, 
one from a state lending agency, one from a mortgage insurer, one from 
a builder, and two from persons whose professional interest in the rule 
could not be determined.
---------------------------------------------------------------------------

    \11\ In some cases, the precise nature of the business was not 
clear from the comment. Moreover, it did not appear that the 
comments differed markedly depending on the precise nature of the 
business. For example, it did not appear that the comments from 
retail lenders differed markedly from those from mortgage brokers, 
or that the comments from one type of retail lender differed from 
those or other types of retail lenders. Thus, all businesses that 
originate, service, and/or broker loans are designated as 
``originators/servicers'' in this preamble.
---------------------------------------------------------------------------

B. What Commenters Commented On

    The Annual vs. Installment Disbursements problem attracted the most 
comments. One-hundred twenty-eight commenters, including all but one of 
the trade associations and all but two of the originators/servicers, 
commented on this issue. The Payment Shock Problem received the second 
highest number of comments, with one-hundred

[[Page 3221]]

sixteen commenters, including ninety-six originators/servicers and all 
but two of the trade associations. The Single-Item Analysis With 
Aggregate Adjustment problem also attracted a significant number of 
comments, seventy-eight in all, including sixty-five originators/
servicers and ten trade associations. Only seventeen commenters, twelve 
originators/servicers and five trade associations, commented on the 
additional proposed change concerning lead-based paint.

C. Overview of Positions

    The overwhelming majority of originators, servicers and mortgage 
brokers opposed those options for the first two issues that were 
designed to provide borrowers more choices, citing the costs and 
burdens of such an approach. Three commenters, including Norwest, 
criticized those options as being inconsistent with the principles the 
Department had articulated, asserting that the Consumer Choice options 
would increase the cost of homeownership. In contrast, the few 
consumers and members of Congress who commented on the first issue 
supported Consumer Choice approaches; these commenters did not comment 
on the Payment Shock problem.
    On the Single-Item Analysis With Aggregate Adjustment problem, more 
commenters supported the proposed change than opposed it. Opinion was 
nearly evenly divided on the additional proposed change concerning 
lead-based paint.
    Nine commenters, including the American Bankers Association (ABA), 
commented that no changes should be made at this time and instead, the 
Department should wait several years before considering further changes 
to Regulation X, at least until the changes made under the 1994-1995 
escrow rules are fully implemented. (Those provisions took effect May 
24, 1995 but provided for a three-year phase in for existing escrow 
accounts which expires October 27, 1997.)
    The reasons given by the ABA, which were echoed by the Oregon 
Bankers Association, for not making any changes to the rule were that 
the rule would alter the escrow accounting systems at the very time the 
Department's new rules are bring fully implemented, causing major 
problems and an excessive burden for banks and other mortgage 
servicers. The New York Credit Union League agreed, emphasizing the 
costly changes that are already being made as a result of that earlier 
rule.
    A bank holding company, in terms echoed by other originators and 
servicers, commented that there was no need to change the rules now as 
those borrowers with existing accounts have already benefited from or 
suffered the consequences of the 1994-1995 escrow rules and have 
subsequently adjusted to the changes and many of the problems created 
by that rule are over. Thus, it would be premature to make further 
changes, and doing so may only again create the same sort of initial 
problems that were created by the 1994-1995 escrow rules. GE Capital 
recommended waiting at least two years before revisiting the need for 
any changes. Another servicer and originator recommended waiting 24 to 
36 months before making further changes. A bank compliance officer and 
a bank holding company also recommended against changes being made at 
this time.
    Several other commenters recommended that the Department hold off 
action on specific portions of the rule. Those comments are analyzed 
separately under the portion of the preamble discussing that aspect of 
the rule.
    In contrast, many commenters emphasized the importance of making 
changes to address their particular issues of concern, particularly the 
Payment Shock problem. These comments are summarized under the 
particular issues discussed later in this summary.

V. Annual vs. Installment Disbursements Problem--Comments Received, 
Approach Adopted in Today's Final Rule, Basis for Approach Adopted, 
Basis for Rejecting Alternative Approaches, Clarifications

A. Comments Received

    Through the comments received on the proposed rule, the Department 
gained a better understanding of the Annual vs. Installment 
Disbursements problem. The Department learned more about how servicers 
have been addressing the problem of setting the appropriate 
disbursement date when given a choice of annual or installment 
disbursements. The comments received indicated that practices have not 
been uniform and that in some cases, originators/servicers have been 
using creative approaches to meeting consumer's needs. Five 
originators/servicers and two tax services indicated that they were 
disbursing in installments unless a discount was offered for annual 
disbursements that the servicer thought was a large enough discount to 
be in the borrower's interest, in which case the disbursements were 
made annually; one trade association indicated this was the approach of 
most of its members as well. One savings and loan indicated that its 
practice was to accommodate individual borrowers by switching people 
who complain to whichever method they prefer.
    Other originators/servicers are using practices that do not provide 
as much flexibility for the consumer. In many cases, the originators/
servicers indicated that they believed such practices were compelled by 
the existing RESPA regulations. For example, thirteen originators/
servicers indicated that when such a choice is offered, they currently 
disburse in installments unless a discount is offered for annual 
disbursements, in which case they always disburse annually regardless 
of how insignificant the discount may be. Two originators/servicers and 
one tax service indicated that if no discount is offered for annual 
disbursements but a service fee is charged for installment 
disbursements, they disburse annually, no matter how insignificant the 
service fee may be.
    A few commenters noted that in many jurisdictions, the installment 
option is only available for individuals, not servicers. Other 
commenters noted special rules that apply in particular States, such as 
Wisconsin, where the practice is to pay taxes in the year levied, even 
though they do not have to be paid until the following year, and 
Maryland, where a law provides that first time homebuyers may choose 
between annual and installment disbursements with a consumer disclosure 
highlighting differences between the two methods.
    The Department also learned more about the discounts obtained by 
servicers for borrowers, e.g., how large the discounts are and when 
disbursements must be made in order to receive the discounts. 
Commenters estimated the size of the discounts to range from around 1-5 
percent of the property tax bill, with only two commenters indicating 
that discounts ranged up to 10 percent, and only one commenter 
indicating they tended to be less than one percent. Several 
commenters--three consumers, two members of Congress, two originators/
servicers, one trade association--expressed the view that discounts are 
small and not in the borrower's interest to disburse in order to 
collect them. Two originators/servicers expressed the opposite view 
that discounts tended to be large and in the borrower's interest to 
obtain. The Department notes that, under reasonable 
assumptions,12 a

[[Page 3222]]

discount of 1 percent of the annual tax bill converts to approximately 
a 4 percent annualized return; a 5 percent discount converts to 
approximately a 23 percent annualized return.
---------------------------------------------------------------------------

    \12\ The assumptions are that if, for example, the entire tax 
bill is paid on January 1, the discount applies to the entire bill. 
Otherwise, half of the bill is due on January 1 and half is due on 
July 1.
---------------------------------------------------------------------------

    Several commenters commented on the extent of the problem. Two 
consumers from New York asserted that borrowers whose servicers 
switched from installments to annual disbursements were adversely 
impacted. One, a senior citizen, explained that she and her husband 
were required by their servicer either to make a lump sum payment of 
almost $1,500 with a monthly increase of over $150 or no lump sum 
payment but a monthly increase of over $200, to obtain a discount of 
only 1 percent. Another reported that his mortgage payment was 
increased over $100 for a mere $8 discount for annual tax payments.
    Other commenters, however, challenged the Department's perspective 
that the issue of Annual vs. Installment Disbursements was a problem in 
need of fixing. Some questioned the Department's evidence that there 
was a problem. One bank expressed doubt about how many borrowers were 
actually affected, and to what extent, by the 1994-1995 escrow rules, 
indicating that the impact of the rule change had already been 
absorbed. Four originators/servicers, including Citicorp and First 
American Real Estate Tax Service, Inc., a large tax service, 
specifically asserted that there was no current problem. Citicorp 
asserted that there were few problems with the existing rule for 
borrowers or industry and that it was premature to change the 1994-1995 
escrow rules until there was more experience operating under it. 
Citicorp recommended waiting until 1998 to make further changes. Ten 
commenters in the origination and servicing industry, including 
NationsBank and GE Capital, as well as the Mortgage Bankers Association 
(MBA), also asserted that the impact of the 1994-1995 escrow rules had 
already been absorbed, and any impacts on consumers with existing loans 
had already taken place.
    Most of the commenters commented on one or more of the specific 
alternative proposals for addressing the problem.13 The 
overwhelming majority of originators, servicers, and mortgage brokers 
opposed Consumer Choice; there was some division of opinion on what 
alternative approach to take. A modified version of the ``Keep But 
Clarify Current Requirements'' alternative garnered the most consistent 
support; the modification was that the restriction on servicers 
switching disbursement methods when servicing is transferred be 
eliminated. Opinion was fairly evenly divided on the merits of the 
``Servicer Flexibility'' alternative.
---------------------------------------------------------------------------

    \13\ In contrast, one commenter, a Wisconsin bank holding 
company, seemed to question the Department's legal authority to 
propose any solution to the problem. The commenter asserted that the 
Department can prohibit over-escrowing and pre-accrual or other 
servicer practices ``that require borrowers to have more than the 
amount of the projected property tax plus the permissible cushion in 
the escrow account before the tax lien attaches, but it was not the 
purpose of Congress that RESPA limit a lender's right to keep 
mortgaged property free of liens, and the authority of the 
Department to interpret RESPA so as to do so is questionable.'' The 
commenter criticized any proposal that would establish detailed 
rules regarding when servicer may disburse funds to pay property 
taxes after the tax lien has attached to the property.
    This objection seems to raise an issue that was settled in the 
May 1995 rule, which elevated cash flow over lien priority. The 
Department has clear legal authority to address the matter of 
disbursements, as part of the Secretary's rulemaking authority 
pursuant to section 19(a) of RESPA (12 U.S.C. 2617) to interpret 
RESPA, including section 10 and section 6(g). Section 10(a) requires 
that disbursements be made in accordance with prudent lending 
practice. Section 10(a)(2) prohibits lenders from requiring 
consumers to deposit in escrow accounts more than one-twelfth of the 
total amount of the estimated taxes, insurance premiums and other 
charges which are ``reasonably anticipated'' to be paid on dates 
during the ensuing twelve months plus a cushion. Section 6(g) 
requires that disbursements be made as payments become due. By 
promulgating a rule to address the Annual vs. Installments 
Disbursement problem, the Department would be acting appropriately 
under one or more of these statutory provisions.
---------------------------------------------------------------------------

1. Comments on Consumer Choice Alternative
    Only seven commenters supported Consumer Choice. The California 
Association of Realtors (CAR) specifically supported applying the 
Consumer Choice option to new loans as well as existing loans. CAR 
commented that the benefits would outweigh the marginal costs and that 
it favored approaches that provide consumers with as much information 
as possible and the opportunity, when fully informed, to make choices 
about the servicing of their loans and the related impound/escrow 
accounting. The CAR added that if the consumer failed to make a choice, 
disbursements should be made on an installment basis.
    Two comments from elected officials, one from Representative Peter 
King of New York and one joint letter from Senator Alphonse D'Amato, 
Representative King, and Representative Dan Frisa also endorsed the 
Consumer Choice approach, focusing on its application to existing 
loans. Both letters expressed deep concern for homeowners who were 
negatively impacted when servicers switched disbursement methods and 
urged the Department to allow homeowners to have the choice to return 
to their prior disbursement method. Representative King's letter stated 
that consumers, not financial institutions, will be able to determine 
which method of tax payment is best for them and that allowing such a 
choice would further the goals of RESPA. Senator D'Amato's letter 
stated that ideally homeowners should be given the option to return to 
their previous disbursement methods with the excess of any escrow 
accounts returned and, at a minimum, their servicers must inquire as to 
the homeowners' preference.
    Four homeowners in New York advocated allowing homeowners to have 
the right to decide whether they wish to forego a discount for annual 
disbursements and instead have their taxes disbursed in installments. 
All focused on the benefits of applying Consumer Choice to existing 
loans, complaining that they were left with a shortage in their account 
and suffered severe financial hardship trying to make up the shortage 
when their servicers switched disbursement methods.
    In addition, one federal credit union's comments gave tepid support 
to the Consumer Choice option if it were limited to new loans. The 
credit union indicated that offering the choice to new loans would only 
entail the burden of preparing and explaining the form. It indicated, 
however, that for existing loans Consumer Choice would be costly in 
terms of staff, time, and the mailing of the selection format, and 
would be confusing to borrowers. The credit union also indicated that 
since borrowers could refinance anyway, there was no apparent need to 
offer existing borrowers a choice.
    In contrast, 107 commenters opposed the adoption of Consumer Choice 
(91 originators/servicers, 11 trade associations, 3 tax services, 2 
financial software companies, and 1 person whose professional interest 
was not known). Only one commenter, a credit union, appeared to limit 
its opposition to the Consumer Choice alternative to its application to 
existing loans. All of the other commenters appeared to oppose the 
application of Consumer Choice regardless of whether it extended to 
both new and existing loans, or only to new loans.
    Most commenters did not separate out their objections to Consumer 
Choice as it would apply to new loans as opposed to existing loans. 
Whether the commenters separated out their objections or not did not 
affect the objections raised. Accordingly, all objections are discussed 
together below,

[[Page 3223]]

with an indication, as applicable, if an objection was raised 
specifically in one context as opposed to another.
    The most common objections made by commenters were:
    1. It would cause miscellaneous or general increases in costs and/
or administrative burdens, such as costs and burdens relating to 
originating or servicing (64 commenters--60 originators/servicers, 3 
trade associations, 1 tax service).
    2. They were concerned about the specific costs and burdens of 
consumer disclosure, including producing and mailing disclosures, 
soliciting preferences, processing disclosures, tracking selection, and 
maintaining information on selection (50 commenters--45 originators/
servicers, 4 trade associations, 1 financial software company) or 
opposed the addition of a new disclosure in general (8 commenters--6 
originators/servicers, 1 financial software company, 1 person of 
unknown professional interest).
    3. It would require more customer service to explain choices and 
answer questions for consumers, which would raise costs, workload, and 
require more staff (46 commenters--41 originators/servicers, 4 trade 
associations, 1 financial software company).
    4. The cost would be passed on to consumers (44 commenters--35 
originators/servicers, 6 trade associations, 2 tax services, 1 
financial software company).
    5. They did not want to make the system and programming changes, 
acquire the new software, or incur the expense of additional 
programming that would be needed (38 commenters--32 originators/
servicers, 3 trade associations, 2 financial software companies, 1 tax 
service).
    6. It would cause consumer confusion and consumers would not be 
able to make an educated choice (30 commenters--25 originators/
servicers, 3 trade associations, 1 financial software company, 1 person 
of unknown professional interest).
    7. They did not want to have to maintain two, or possibly many 
more, different disbursement systems for every taxing jurisdiction 
where they service loans (24 commenters--18 originators/servicers, 5 
trade associations, 1 tax service).
    8. It would lead to more errors and could result in missed payments 
and interest and penalties (24 commenters--21 originators/servicers, 1 
trade association, 1 tax service, 1 financial software company).
    9. It would create hardship for taxing authorities (18 commenters), 
such as increased administrative costs/burden and workload due to lack 
of uniformity and similar factors (12 originators/servicers), 
unexpected shortfalls in tax receipts (8 commenters--7 originators/
servicers, 1 trade association), and unspecified or miscellaneous 
difficulties (2 originators/servicers).
    10. It would require additional training of staff (8 commenters--7 
originators/servicers, 1 trade association) or require additional staff 
and/or staff time for processing (13 commenters--12 originators/
servicers, 1 trade association).
    11. It would result in impossibilities and impracticalities (15 
commenters) including that computer and other systems could not handle 
Consumer Choice (6 commenters--5 originators/servicers, 1 trade 
association).
    12. It would increase the need for manual processing or interfere 
with technological advances (12 commenters--10 originators/servicers, 1 
tax service, 1 financial software company).
    13. It would be less efficient (11 commenters--10 originators/
servicers, 1 trade association).
    14. It would result in a loss of uniformity (10 commenters--9 
originators/servicers, 1 trade association).
    In addition, several commenters indicated that several aspects of 
the Consumer Choice alternative in the proposed rule were unclear and 
required further clarification. For example, eight originators/
servicers and a trade association indicated that the proposed rule was 
not sufficiently clear about what would happen if the customer did not 
return the format or how a servicer should document that a borrower 
made no selection. Several commenters recommended that if the 
Department were to proceed with Consumer Choice, it should make 
variations of one type or another from the way in which it was 
proposed.
    In its proposed rule, the Department asked Question 4, which was 
designed to learn more about the potential impact on servicers of 
requiring them to provide borrowers with a one-time choice at closing 
as opposed to allowing borrowers to switch disbursement methods during 
the life of the loan. The answers received to this question 
substantially overlapped with the comments discussed above regarding 
the benefits and disadvantages of Consumer Choice.
    Twenty-eight commenters (24 originators/servicers, 3 trade 
associations, 1 tax service) explicitly indicated in their responses to 
this question that not even a one-time choice should be provided to 
consumers, but that if the Department chose the Consumer Choice 
alternative anyway, it should be limited to a one-time choice. This 
view was implicit in the comments of several others. Among the 
drawbacks cited for providing more than a one-time choice were the 
following:
    1. It would increase the burden if servicers needed to make 
constant changes (nine commenters--eight originators/servicers, one 
trade association).
    2. It would result in higher costs (eight commenters--seven 
originators/servicers, one tax service).
    3. It would lead to more errors, confusion, uncertainty and/or 
noncompliance (seven commenters--five originators/servicers, one trade 
association).
    4. It would be impossible, impractical, or unfair (five 
originators/servicers).
    In its proposed rule, the Department also asked three related 
questions (Questions 2, 5, and 11) that were designed to elicit 
responses as to whether, in general, the approach in the final rule 
should make a distinction between loans that settle before the 
effective date of a final rule and loans that settle on or after the 
effective date. While the Department posed the questions so as to be 
applicable regardless of which alternative was selected, virtually all 
who answered the questions did so in the context of applying Consumer 
Choice. The answers received to these questions substantially 
overlapped each other, as well as overlapping with the comments 
received on Consumer Choice, and thus are discussed together here.
    Fourteen commenters--twelve originators/servicers and two trade 
associations--emphasized the drawbacks to applying new rules to 
existing loans, as opposed to only applying it to new loans. The 
drawbacks to applying consumer choice to all loans included: (1) it 
would be more costly/burdensome to apply to all (eight commenters); (2) 
it may result in shortages (two commenters); and (3) it would cause 
more confusion, disruption, and/or chance for error (two commenters).
    In contrast, 13 commenters--11 originators/servicers, 1 trade 
association, and 1 financial software company--emphasized the drawbacks 
to trying to apply new rules only to new loans, thereby requiring 
maintaining separate rules for a portion of their portfolio. These 
commenters either supported or leaned toward uniform treatment of all 
loans, some with mixed feelings about the significant burdens it would 
impose to apply a change to existing loans. The drawbacks cited

[[Page 3224]]

included: (1) the need for uniformity and consistency (five 
commenters); (2) it would be costly and burdensome to distinguish (four 
commenters); (3) it would result in more borrower confusion or 
dissatisfaction (three commenters); (4) taxing authorities could not 
gauge the number and amount of tax payments (two commenters); and (5) 
more errors would result.
    Finally, in the proposed rule the Department asked Question 10, 
which was designed to elicit comments on whether the Department should 
apply a Consumer Choice approach to other escrow items for which a 
choice between installments and annual disbursements may be offered. No 
commenter gave a clear answer that supported applying a consumer's 
choice to other escrow items. In contrast, 27 commenters (23 
originators/servicers and 3 trade associations) opposed extending a 
consumer's choice to other escrow items. The reasons given for opposing 
such an approach included the following:
    1. Additional costs and burdens would result (e.g., insurance 
companies impose a service charge for installment payments and this 
would be passed on to consumer) (19 commenters--17 originators/
servicers, 2 trade associations).
    2. There would be no benefit to consumers (e.g., taxes are the 
largest item so the savings from installments will be negligible) (10 
commenters--9 originators/servicers and 1 trade association).
    3. More errors, customer dissatisfaction, and customer confusion 
would result (six commenters--five originators/servicers and one trade 
association).
2. Comments on Servicer Flexibility Alternative
    Twenty-five commenters--18 originators/servicers, 5 trade 
associations, 1 tax service, and 1 financial software company--
supported Servicer Flexibility. Eight of these commenters (seven 
originators/servicers and one financial software company) who otherwise 
supported Servicer Flexibility, however, did not support the aspect of 
Servicer Flexibility that would have included restrictions on changing 
disbursement methods when servicing rights were transferred. Indeed, 
two of these originators/servicers made a special point of indicating 
that they would not support Servicer Flexibility if it included that 
element.
    The most common reasons for supporting Servicer Flexibility 
included:
    1. It would be flexible (six commenters--three originators/
servicers, three trade associations).
    2. It would be easy to administer and cause little disruption (five 
commenters--two originators/servicers, two trade associations, one 
financial software company).
    3. It would not be costly (four originators/servicers).
    4. The lender/servicer is likely to do what is in the consumer's 
interest anyway; Servicer Flexibility would allow servicers to 
accommodate borrowers (four commenters--two originators/servicers, two 
trade associations).
    In contrast, 19 commenters--14 originators/servicers, 4 trade 
associations, and 1 tax service--opposed Servicer Flexibility. The 
reasons for opposing Servicer Flexibility included:
    1. It would not create a system that is uniform, standardized, 
consistent, or certain; there would still be no clarity (12 
commenters--9 originators/servicers, 2 trade associations, 1 tax 
service).
    2. The restriction on changing disbursement methods when there is a 
transfer of servicing or reasons related thereto was objectionable 
(five commenters--three originators/servicers, one trade association, 
one tax service).
    3. Increased costs would result (five commenters--four originators/
servicers, one trade association).
    4. It might not result in the best method for consumers (two 
originators/servicers, one trade association) and litigation would 
result (two originators/servicers).
    In addition, one federal credit union suggested that the Department 
adopt a variation on Servicer Flexibility under which the servicer 
should notify the borrower when the disbursement method is being 
changed, changing should be limited to when it benefits the borrower 
(such as taking advantage of a sufficient discount), and the annual 
statement could be used to inform the borrower of the method used.
3. Comments on Keep, But Clarify, Current Requirements Alternative
    Sixty-five commenters--58 originators/servicers, 4 trade 
associations, 1 tax service, 1 financial software company, and 1 State 
lending agency--supported the Keep, But Clarify, Current Requirements 
alternative. Six other commenters (two originators/servicers, three 
trade associations, and one tax service) indicated it was their second 
choice. Forty-eight of the commenters who otherwise supported Keep, But 
Clarify, Current Requirements as either their first or second choice 
(46 originators/servicers, 1 trade association, and 1 State lending 
agency), did not support the aspect of this alternative that would 
include restrictions on changing disbursement methods when servicing 
rights were transferred. Indeed, 30 of these commenters specifically 
emphasized their objection to this aspect of this alternative in 
discussing the support they otherwise would give to it.
    The reasons given by those who supported Keep, But Clarify, Current 
Requirements as their first choice were substantially the same as the 
reasons given by the three originators/servicers who indicated it was 
their second choice. The most common reasons of both groups of 
commenters included:
    1. It would be good for consumers for miscellaneous or unspecified 
reasons (26 commenters--24 originators/servicers, 1 State lending 
agency, 1 financial software company) or because it would be flexible 
and allow accommodating customers (8 commenters--5 originators/
servicers, 3 trade associations).
    2. It would cause little disruption, would not be burdensome, would 
not require much change, and would be efficient (11 commenters--8 
originators/servicers, 2 trade associations, 1 State lending agency).
    3. It would not be costly and any costs associated with it would be 
within an acceptable range (eight commenters--six originators/
servicers, two trade associations).
    4. It would be a balanced, sensible, practical compromise (six 
commenters--five originators/servicers, one trade association)
    5. It was favored but no specific reason was given (20 commenters--
17 originators/servicers, 2 trade associations, 1 tax service).
    In contrast, eight originators/servicers and two trade associations 
opposed Keep, But Clarify, Current Requirements. The most common 
reasons given for opposing it included the following:
    1. It would not standardize the industry (two originators/
servicers).
    2. It would be unclear, vague, and not specific (two originators/
servicers).
    3. It would be bad for consumers (e.g., consumer dissatisfaction, 
confusion, disruption, loss of tax deduction) (two originators/
servicers, one trade association).
    4. It would be objectionable because of the restriction on 
switching disbursement methods when there is a transfer of servicing 
(two commenters--

[[Page 3225]]

 one originator/servicer, one trade association).
    Several commenters recommended variations on Keep, But Clarify, 
Current Requirements such as requiring installments unless there is a 
discount for annual disbursements, in which case making annual 
disbursements mandatory to get the discount instead of optional for 
servicer. Other commenters encouraged the Department to consider other 
approaches, such as making no changes at all to address this problem.
4. Comments on Proposed Rule Provision Prohibiting Switching 
Disbursement Methods Without Borrower's Consent
    Only seven commenters supported, in any context, prohibiting a 
servicer or transferor servicer from changing the disbursement method, 
as long as a choice exists, without the borrower's prior written 
consent. Two appeared to support it as a general proposition regardless 
of the alternative selected. One was Senator D'Amato, who asserted that 
changes without the borrower's approval ``have been the primary culprit 
in the unfair treatment which mortgage lenders have imposed on the 
homeowners of Long Island, chiefly by requiring hundreds of dollars per 
month from homeowners in escrow payments in order to take advantage of 
minuscule discounts through the payment of local taxes on an annual 
basis.'' The other was a federal savings bank, which gave no specific 
reasons other than suggesting it would be less complicated to do so.
    One servicer indicated that if Servicer Flexibility were adopted, 
it would be logical to prohibit subsequent servicers from changing the 
disbursement method without the borrower's written consent. This 
commenter stated that it understands the need to get the borrower's 
consent before changing the method of tax disbursements when servicing 
is transferred.
    Were the Department to adopt the alternative of Keep, But Clarify, 
Current Requirements, three commenters supported the restriction. 
America's Community Bankers (ACB) supported the restriction, so long as 
the disbursement method continues to be offered by the taxing 
authority. A large bank with a mortgage lending subsidiary endorsed 
allowing servicers and subsequent servicers to change the disbursement 
method only to bring the escrow account into compliance with RESPA 
under a revised interpretation by the Department. One other servicer 
commented that requiring the same disbursement date when servicing is 
transferred is beneficial in that it protects against payment shock for 
borrowers.
    In contrast, 71 commenters opposed the restriction. Fifty-seven of 
those who opposed it (including 21 originators/servicers submitting the 
same form letter) discussed their opposition as a general objection 
applicable to whichever of the three alternatives for addressing the 
Annual vs. Installment Disbursements problem might be adopted. These 57 
included 51 originators/servicers, 4 trade associations, a State 
lending agency, and a financial software company. Fourteen expressed 
their opposition in connection with one or more of the specific 
alternative solutions proposed, but none of these commenters either 
stated or suggested that the proposal would be acceptable in the 
context of a different alternative being adopted. Since the objections 
were consistent regardless of whether expressed in connection with one 
or all alternatives, all the comments on this issue are discussed in 
this section. One servicer specifically said that it opposed all the 
alternatives presented in the proposed rule because of this common 
feature.
    The arguments against including the restriction in the final rule 
primarily focused on the way in which such a restriction would impair 
the value of servicing rights and the costs and administrative burdens 
associated with the restriction. Many of the arguments against the 
restriction overlapped each other. The most common reasons given 
included that:
    1. It would result in a variety of miscellaneous administrative 
burdens (35 commenters--34 originators/servicers and 1 trade 
association).
    2. It would increase costs for servicers, such as system and 
processing changes including computer system changes and the burden on 
the due diligence process (14 commenters--12 originators/servicers and 
2 trade associations) and would increase costs to consumers (6 
commenters--4 originators/servicers and 2 trade associations).
    3. The restriction would impair the value of servicing rights (13 
commenters--10 originators/servicers, 2 trade associations, 1 State 
lending agency), such as by creating inefficiency and increased cost (3 
originators/servicers, 1 trade association).
    4. As the restriction applies to the Keep, But Clarify, Current 
Requirements alternative, it would be a new requirement, rather than a 
clarification of an existing requirement (seven commenters--six 
originators/servicers and one trade association).
    5. It would result in a variety of practical difficulties or 
impossibilities (six commenters--five originators/servicers and one 
trade association).
    6. It would reduce the number of sales and transfers of servicing 
rights (five commenters--four originators/servicers and one trade 
association).
    7. No problem exists that needs to be fixed by such a restriction 
(five originators/servicers).
    In addition, three commenters (two originators/servicers, one trade 
association) indicated their belief that the Department would lack 
legal authority to mandate such a restriction. Three originators/
servicers requested that the Department clarify certain points 
pertaining to this restriction.
    Six commenters proposed variations on the restriction. Three 
commenters supported limiting the ability of the acquiring servicer to 
change the disbursement method to particular types of situations. One 
federal credit union indicated that it supported restricting a servicer 
acquiring servicing rights from changing disbursement methods unless 
the change would benefit the borrower, but gave no details on how to 
apply such a standard. The Georgia Housing and Finance Administration 
favored limiting servicers from making changes to the disbursements 
method to situations involving transfers of servicing, borrower 
hardships, taxing authority changes, system conversion, and other major 
organizational changes. GE Capital asked the Department to allow a 
change in disbursement dates or methods after a transfer of servicing 
if the dates are incorrect or the methodology is not available to the 
new servicer. Three mortgage companies suggested that servicers should 
simply include in the letter notifying the consumer of a transfer of 
servicing what disbursement method will be used, prior to making the 
change.

B. Approach Adopted in Today's Final Rule

    Having carefully analyzed the comments received, the Department has 
decided to adopt, with modifications, the Keep, But Clarify, Current 
Requirements alternative. The Department is revising the rule to 
provide that servicers must make timely payments, that is, on or before 
the deadline to avoid a penalty, and advance funds as necessary, so 
long as the borrower's payment is not more than 30 days overdue. The 
rule also provides special requirements for property taxes when the 
taxing jurisdiction offers the servicer a choice between annual 
disbursements with a discount and installment disbursements. In such

[[Page 3226]]

cases, if the taxing jurisdiction neither offers a discount for 
disbursements on a lump sum annual basis nor imposes any additional 
charge or fee for installment disbursements, the servicer must make 
disbursements on an installment basis, unless the servicer and borrower 
agree otherwise. If, however, the taxing jurisdiction offers a discount 
for disbursements on a lump sum annual basis or imposes any additional 
charge or fee for installment disbursements, the servicer may, at the 
servicer's discretion (but is not required by RESPA to), make lump sum 
annual disbursements, as long as such method of disbursement complies 
with the requirements of Sec. 3500.17 (k)(1) and (k)(2) of this rule. 
HUD encourages, but does not require, the servicer to follow the 
preference of the borrower, if such preference is known to the 
servicer.
    This final rule also incorporates into the regulations a provision 
that the servicer and borrower may mutually agree, on an individual 
case basis, to a different disbursement basis (installment or annual) 
or disbursement dates, than the rule would otherwise require. This 
provision is consistent with, but more expansive than, the statement 
contained in the discussion in the preamble to the Department's May 9, 
1995 rule (60 FR 24734), which indicated that such agreements were 
allowed after settlement only. At the time the preamble to the May 1995 
rule was written, the Department felt that the concern for borrower 
coercion was so great as to make it necessary to limit agreements 
concerning disbursement dates to the period after settlement, when the 
likelihood of coercion was reduced. The Department understands, 
however, that allowing such agreements only after settlement 
discourages them, since it is more burdensome to change the 
disbursement basis or date after settlement than to set up the account 
from the start in a way that is mutually agreeable to the borrower and 
servicer.
    This final rule emphasizes that these agreements must be completely 
voluntary and that neither loan approval nor any term of the loan may 
be conditioned on the borrower's agreeing to a different disbursement 
basis or disbursement date for property taxes. The rule does, however, 
allow such agreements to be made prior to settlement, thereby avoiding 
the need to make postsettlement changes in the disbursement basis or 
dates when such an agreement is reached before settlement. This rule 
also clarifies that whatever the borrower and servicer agree to must 
avoid a penalty, comply with normal lending practice of the lender and 
local custom, and constitute prudent lending practice. This new 
provision provides flexibility. It allows the parties to agree, for 
example, to annual disbursements of property taxes even if there is no 
discount where an installment option is offered.
    This final rule departs from Keep, But Clarify, Current 
Requirements as articulated in the proposed rule in that, under this 
final rule, the only specific requirements for choosing between annual 
and installment disbursements pertain to property taxes, not other 
escrow items. The reason the Department distinguishes property taxes 
from other escrow items is that the concerns that have been raised to 
the Department on the Annual vs. Installment Disbursement issue have 
been limited to property taxes. For most consumers, property taxes are 
much larger than hazard insurance and other escrow items.
    This final rule also departs from Keep, But Clarify, Current 
Requirements as articulated in the proposed rule in that, for the 
reasons discussed in Part V(D)(3) of this preamble below, it does not 
adopt the restriction in the proposed rule that a servicer and 
subsequent servicers would be prohibited from changing the method of 
disbursement without the borrower's prior written consent, as long as a 
choice continues to exist in the taxing jurisdiction.
    Finally, the final rule adds a definition of ``penalty'' to the 
definitions in Sec. 3500.17. This definition clarifies that a penalty 
means a late charge imposed for paying after the disbursement is due. 
It does not include any additional charge or fee associated with 
choosing installment disbursements as opposed to annual disbursements 
or for choosing one installment plan over another. In comments on the 
proposed rule, four originators/servicers and one tax service commented 
that the proposed rule had been unclear whether a service fee levied on 
installment disbursements is regarded as a penalty. These commenters 
took the position that the servicers may or must use annual 
disbursements to avoid a penalty (service charge, interest payment, or 
other fee) for paying in installments, not just to take advantage of a 
discount available for annual disbursements. One of these commenters 
questioned whether the existence of a service charge for installment 
disbursements makes an annual disbursement plan without such a service 
charge the equivalent of a discount.
    Notwithstanding these comments, the Department believes the better 
approach is not to regard a service charge, interest payment, or other 
fee associated with choosing installment disbursements as opposed to 
annual disbursements as a penalty to be avoided. Rather, if a service 
charge, interest payment, or other fee is imposed for choosing 
installment disbursements as opposed to annual disbursements, the 
ability to avoid them by paying annually creates, in essence, a 
discount for annual disbursements. With respect to disbursements for 
property taxes, once the choice is viewed as between annual 
disbursements at a discount and installment disbursements, in 
accordance with this rule, the servicer may, but is not required by 
RESPA to,14 pay annually. Thus, for property taxes, the 
servicer may choose to disburse the property taxes in installments and 
incur the service charge, interest payment, or other fee associated 
with choosing installment disbursements, or may avoid them by 
disbursing annually. The servicer is encouraged, but not required, to 
follow the preference of the borrower.15
---------------------------------------------------------------------------

    \14\ The caveat, ``by RESPA,'' is designed to allow for the 
possibility that State law could require annual disbursements.
    \15\ For other escrow items, the servicer may disburse annually 
or in installments, so long as the method avoids a penalty and the 
disbursement basis and disbursement date complies with the normal 
lending practice of the lender and local custom, and constitutes 
prudent lending practice.
---------------------------------------------------------------------------

    Stated in other terms, for property taxes, the servicer should add 
up the total payments associated with disbursing annually and compare 
that amount to the total payments associated with disbursing in 
installments. In making those calculations, the servicer should take 
into account any applicable discounts or service charges. If the total 
amount associated with disbursing property taxes annually is greater 
than or equal to the total amount associated with disbursing in 
installments, the servicer must disburse the property taxes in 
installments, except when the servicer and borrower mutually agree 
otherwise. If, however, the total amount for disbursing the property 
taxes in installments is greater than the total amount for disbursing 
them annually, the servicer may, but is not required by RESPA to, 
disburse them annually. The servicer is encouraged, but not required, 
to follow the preference of the borrower.

C. Basis for Approach Adopted

    The preamble to the proposed rule indicated that the Department 
believed the advantage of Keep, But Clarify, Current Requirements would 
be that, like Servicer Flexibility, it would provide flexibility to 
servicers. It would also allow servicers to accommodate borrowers with 
a particular preference.

[[Page 3227]]

To the extent that the Department thought Keep, But Clarify, Current 
Requirements had a potential drawback, it was that it would not 
guarantee that servicers would accommodate the preferences of 
individual borrowers, providing less choice for borrowers.
    The comments received served to confirm the Department's belief 
that Keep, But Clarify, Current Requirements, with some modifications, 
is a workable solution to this problem. Commenters noted many positive 
reasons for choosing this alternative. The Department is persuaded 
that, on balance, it is the best approach for meeting consumers' needs 
and balancing those against the valid concerns of the industry. Such an 
approach will cause the least disruption and burden and will be the 
least costly approach, yet it is sufficiently flexible to accommodate 
the preferences of individual consumers.
    By clarifying the regulations in a way that allows more flexibility 
for servicers and consumers, the Department intends to encourage more 
servicers to adopt the types of best practices that some servicers are 
already using that ensure flexibility for consumers. These best 
practices to address the Annual vs. Installment Disbursements problem 
include:
     Disbursing property taxes in installments unless a 
discount is offered for annual disbursements that the servicer, based 
on its best business judgment, believes is a large enough discount to 
be in the borrower's interest, in which case the servicer makes 
disbursements annually.
     Accommodating individual borrowers by switching borrowers 
who complain to whichever method they prefer for the disbursement of 
property taxes.
    These two practices are examples of the types of best practices 
that some originators/servicers in the industry are using today, even 
without a Government requirement. The Department would encourage 
servicers to adopt these practices so that they will become more 
widespread.
    In contrast, the Department intends to discourage practices that do 
not provide as much flexibility for the consumer. These include:
     If a choice between annual disbursements with a discount 
or installment disbursements is offered, always disbursing annually 
regardless of how insignificant the discount may be and despite the 
consumer's stated preference for installment disbursements.
     If a choice between annual disbursements or installment 
disbursements with an additional charge or fee for installment 
disbursements is offered, always disbursing annually regardless of how 
insignificant the charge or fee for installment disbursements may be 
and despite the consumer's stated preference for installment 
disbursements.
    The Department intends that the revisions made in this final rule 
clarify that these two inflexible practices were not, and are not, 
compelled by the Department; the Department does not in any way mandate 
such practices. The Department encourages servicers to use practices 
that are more consumer friendly.

D. Basis for Rejecting Alternative Approaches

1. Rejection of Consumer Choice Alternative
    The preamble to the proposed rule indicated that this approach 
would provide the greatest flexibility to the borrower. However, the 
Department also noted that it could impose higher costs on servicers. 
The Department observed that servicers would likely need two different 
disbursement systems to reflect the disbursement preferences of 
borrowers.
    While the Department believes that it would have legal authority to 
impose Consumer Choice as part of the Secretary's rulemaking authority, 
it has decided not to do so. The Department is persuaded that the types 
of costs and burdens associated with such an approach are unwarranted 
at this time. The cost of implementing Consumer Choice with respect to 
disbursing property taxes on an installment or annual basis would be 
substantial according to most of the comments received on this issue. 
New software and operating procedures would have to be developed for 
originators and all those involved in servicing. Some efficiencies 
would be lost as multiple processes were employed for making 
disbursements to taxing authorities, when only one process had been 
followed before.
    Additionally, the Department gathered information from members of 
the servicing industry on the cost of the Consumer Choice alternative. 
The Department believes that the cost per account subject to Consumer 
Choice would be significant, even under a very simple system subject to 
the following assumptions: (1) a choice would only be permitted at 
origination with no provisions for the consumer to opt to change the 
disbursement method later and (2) little in terms of disclosure to the 
consumer would be provided other than notifying the consumer that a 
one-time choice at origination was permitted. To the extent that the 
disclosure required more information or the consumer could opt to 
change the disbursement method during the life of the loan, the costs 
would be greater.
    The additional costs of consumer choice could be justified if there 
were commensurate benefits to consumers. But the vast majority of 
consumer complaints concerning the disbursement method arose out of the 
transition associated with the 1994-1995 escrow rules. These were one-
time, as opposed to ongoing, problems. Complaints about this problem 
have recently become rare.
    Given that the transition associated with the 1994-1995 escrow 
rules is almost complete and that this transition has been the source 
of essentially all the complaints concerning the Annual vs. Installment 
Disbursements problem, the Department believes that only a small 
percentage of consumers would benefit from the Consumer Choice 
alternative. It is not anticipated that the benefits to the few who 
would choose a basis other than what the servicer would choose under 
the rule would exceed the costs associated with that option. Since it 
is consumers who would probably bear the additional costs of providing 
choice, the Department does not believe it is in the consumers' overall 
best interest to require consumer choice.
    The Department was also influenced by the lack of consensus among 
the commenters on the technical details of the Consumer Choice 
alternative. The Department asked several specific questions about how 
to implement such an option in the way least disruptive to the 
industry. The answers received further reflected the uncertainties and 
disruptions that would be created by imposing the Consumer Choice 
alternative and helped convince the Department that such an approach is 
not feasible. Since the Department is not adopting the Consumer Choice 
alternative in this final rule, the responses received to a number of 
the questions raised in the proposed rule do not merit detailed 
discussion, but a brief summary of the comments in response to these 
questions is provided below to convey the divergent opinions on this 
subject.
    1. The Department asked Question 7, which was designed to elicit 
comments on when the appropriate time would be for the originator or 
servicer to provide the borrower the disclosure, if the Consumer Choice 
alternative were to be adopted. The commenters were fairly evenly 
divided on whether the disclosure should be provided and the

[[Page 3228]]

selection made before closing but after underwriting or before 
underwriting. Thirteen commenters simply indicated sometime before 
closing, whereas 12 commenters indicated it would have to be before 
underwriting. Seven commenters specifically indicated that the 
selection would affect underwriting, whereas three commenters 
specifically indicated that the selection should not affect 
underwriting.
    2. The Department asked Question 8, which was designed to elicit 
comments about whether the Department should prescribe a disclosure 
format if an approach were adopted in which the borrower's preference 
for installments or annual disbursements were controlling. There was 
general agreement that the Department should prescribe the format (20 
commenters supporting prescribing it, with only 4 opposed). However, 
there was disagreement over what the disclosure should say. Six 
commenters supported the disclosure the Department had proposed, if one 
was to be mandated. Seven commenters, however, said it was too 
confusing and/or unclear. Four criticized it for containing too much 
information or being overwhelming whereas, two criticized it for not 
including enough information.
    3. The Department asked Question 9, which inquired what period of 
time would be needed for servicers to be able to implement the Consumer 
Choice alternative. Four commenters said it could be implemented in 
less than 12 months, 9 commenters indicated 12 months or more, 2 
commenters said 18 to 24 months, and 4 commenters estimated it would 
take 24 months.
2. Rejection of Servicer Flexibility Alternative
    The preamble to the proposed rule explained that the Department 
perceived this alternative as being the least intrusive regulatory 
approach for the Department to take and providing the greatest 
flexibility to servicers, while leaving servicers free to accommodate 
borrowers with a particular preference, as long as the borrowers' 
preferences were in accordance with the normal lending practice of the 
lender and local custom and constituted prudent lending practice. The 
Department noted that the disadvantage of this alternative is that it 
would not guarantee that servicers would accommodate the preferences of 
individual borrowers and, therefore, it provided less choice for 
borrowers.
    The Department has decided not to adopt the Servicer Flexibility 
alternative. Most commenters did not favor such an approach. The 
Department decided that there is no reason to adopt this approach and 
that it would not necessarily be best for the consumer.
3. Rejection of Prohibiting Switching Disbursement Methods Without 
Borrower's Consent
    While the Department would have legal authority to impose a 
restriction against switching disbursement methods without the 
borrower's consent as part of the Secretary's rulemaking authority, it 
has decided not to do so. The types of costs and burdens associated 
with such a restriction are unwarranted. Therefore, this final rule 
does not contain this restriction as part of the approach adopted.

E. Clarifications

    In issuing this final rule, the Department wishes to address 
several questions from commenters that will clarify the rule.
1. Selecting From Among Various Installment Plans Offered
    Several commenters requested clarification of the servicer's 
obligations when a taxing authority offers several different 
installment plans. In such circumstances, the Department encourages the 
servicer to use the installment plan that results in the lowest closing 
costs for the consumer. However, the servicer is free to make 
disbursements according to any installment plan offered by the taxing 
jurisdiction so long as the selection complies with the normal lending 
practice of the lender and local custom, and the installment plan 
selected constitutes prudent lending practice. The servicer may also 
make disbursements according to any installment plan offered by the 
taxing jurisdiction to which the servicer and borrower may mutually 
agree, on an individual case basis.
2. The Size of the Discount Does Not Matter
    One mortgage company commented that the Department should make the 
application of the Keep, But Clarify, Current Requirements approach 
more consistent by establishing a guideline on when to switch to annual 
disbursements to take advantage of a discount. One tax service 
indicated that when the payee offers a choice between installments and 
annual disbursements at a discount, the Department should either 
require maximum discounts be taken or set a threshold and require the 
servicer to disburse to obtain any maximum discount meeting or 
exceeding that minimum.
    In its proposed rule, the Department asked Question 6, which 
specifically solicited comments on whether the size of an available 
discount should matter and, if so, how. Fifteen commenters--11 
originators/servicers, 1 trade association, 2 tax services, and 1 
financial software company--indicated that the size of the discount 
should make a difference under the rule in some fashion. Eight 
commenters indicated that the rule should provide that if the discount 
offered meets a Department-determined threshold, the servicer must 
disburse annually to obtain the discount. Three commenters indicated 
that the rule should provide that the servicer is free to decide if the 
discount is large enough to make it worthwhile to make disbursements in 
such a way as to collect the discount.
    Among those who favored making the size of the discount matter 
under the rule, there was no agreement on the best approach to setting 
the discount threshold that would trigger application of one rule or 
another. Five commenters opposed tying the discount threshold to a 
market rate, while only one supported this approach. Five commenters 
favored, but two commenters opposed, a ``reasonable servicer'' 
standard. One large tax service commented that not just the size of the 
discount, but several other factors, affect the value of the discount 
to the consumer, such as the rate of interest (if any) paid on escrow 
accounts, market interest rates, and the borrower's income tax rate.
    In contrast, 16 commenters--15 originators/servicers and 1 trade 
association--indicated that the size of the discount should not make a 
difference under the rule. These commenters indicated that such 
consideration would present an additional burden and cost to calculate 
the size of the discount and that discounts are beneficial to the 
consumer regardless of the size.
    The Department has not adopted the approach of making the size of 
the discount a determinative factor in which disbursement method the 
servicer should use. There is no apparent way to arrive at a reasonable 
and acceptable guideline. Rather, the Department's approach in this 
rule allows latitude to the servicer, while encouraging the servicer to 
follow the preference of the borrower.
3. Application of Rule to Other Escrow Items
    Two originators/servicers commented that this rule should clarify 
that the Department's policy of favoring installments only applies to 
taxes, not other escrow items such as hazard

[[Page 3229]]

insurance. One of these commenters added that this rule should clarify: 
(1) that servicers should disburse mortgage insurance payments monthly 
or annually; and (2) that hazard insurance payments should be disbursed 
annually or as billed by the insurer, and if discounts are available 
for annual disbursements it should be disbursed annually.
    Under this final rule, the only specific requirements for choosing 
between annual and installment disbursements pertain to property taxes, 
not other escrow items such as hazard insurance. For escrow items other 
than property taxes, if a payee offers a servicer a choice between 
installment or annual disbursements, the servicer is required to make 
disbursements by a date that avoids a penalty. The servicer, however, 
is otherwise free to make disbursements on such disbursement basis 
(annual or installments) and disbursement date as complies with the 
normal lending practice of the lender and local custom, provided that 
the selection of each such basis and date constitutes prudent lending 
practice. The reason for distinguishing property taxes from other 
escrow items is explained in Part V(B) of this preamble, above.
4. No Preemption of State Law on Installment Option
    Two commenters requested clarification of whether RESPA preempts 
State law in such a way as to require that States offer an installment 
payments option to servicers, or if they currently only offer that 
option to individual borrowers. The answer to that question is that 
RESPA does not so preempt State law. Whether taxing jurisdictions 
should make an installment option available to servicers is a matter of 
State law, not RESPA.
5. Disbursing Annually Instead of in Installments When There is no 
Discount if a Choice is Offered
    One commenter, a Wisconsin bank holding company, raised a concern 
regarding escrow accounts in Wisconsin, stating that servicers should 
be able to make tax disbursements in an annual disbursement rather than 
installments, if a choice is offered, even if there is no discount for 
annual disbursements. The commenter represented that this was partly to 
protect the servicer's lien, which becomes effective on the first of 
the year in which the taxes are billed, and partly to give the borrower 
the benefit of tax deductions for the current year. The commenter 
explained that in Wisconsin, taxes are billed in November and can be 
paid in two installments in the following January and July. In 
addition, State law requires the servicer to issue a joint check to the 
borrower and the taxing authority by December 20, or give the borrower 
three options: (1) Pay in full by December 31 if the tax bill is 
received by December 20, (2) pay the full tax when due (January and 
July installments), or (3) issue a joint check to the borrower and 
taxing authority by December 20. If the servicer offers the three 
options, the servicer is required to follow the borrower's preference.
    The commenter asserted that for the Department effectively to 
prohibit the December payment would conflict with the Department's 
prior guidance set forth in the preamble to the February 15, 1995 rule 
(60 FR 8813, second column), which specifically allowed the practice. 
The commenter further argued that a substantial change in 
interpretation would undercut servicers who relied on the Department's 
prior advice, would force servicers to disregard State law, and would 
negatively impact on borrowers' tax deductions.
    In response to this and other comments, this final rule adds a 
provision to the regulations (Sec. 3500.17(k)(4)) specifying that a 
servicer and borrower may mutually agree, on an individual case basis, 
to a different disbursement basis (installment or annual) or 
disbursement date than that which would otherwise be prescribed under 
the regulations. This addition should address the commenter's concern 
and allow the servicer to comply with Wisconsin law.

VI. Payment Shock--Comments Received, Approach Adopted in This 
Final Rule, Basis for Approach Adopted, Basis for Rejecting 
Alternatives

A. Comments Received

    Through the comments received on the proposed rule, the Department 
gained a better understanding of the payment shock problem. A few 
commenters pointed out that there could be other causes of payment 
shock aside from those that the Department had described in the 
preamble to the proposed rule. Citicorp pointed out that payment shock 
can also be caused by rate adjustments to Adjustable Rate Mortgages 
(ARMs), special tax assessments, and additional insurance coverage 
selected by borrowers after closing.
    The Department also learned more about how servicers have been 
addressing the problem of payment shock. Eight originators/servicers 
indicated that their practice is to notify borrowers ahead of time and 
provide an opportunity to make voluntary payments ahead of schedule to 
avoid payment shock. Seven originators/servicers indicated that they 
offer consumers extended repayment plans, even beyond those required 
under RESPA, to make up shortages that result from payment shock. Nine 
originators/servicers indicated that they use short-year statements to 
minimize payment shock, a practice that also is useful. Two 
originators/servicers indicated that they simply notify borrowers ahead 
of time that payment shock may occur but do not explain how to avoid 
it.
    The Department solicited comments to gauge the extent of the 
payment shock problem. Four originators/servicers and one home builder 
specifically commented that they agreed with the Department's 
assessment that payment shock is a very significant problem that needs 
to be addressed. One commenter estimated that roughly 50 percent of its 
customers experience payment shock because 30 percent of its loans are 
for new construction on which taxes are initially assessed on 
unimproved property and then reassessed for the improvements; an 
additional 20 percent of its loans have prepaid taxes.
    The view that payment shock was a problem was implicit in the 
comments of several others, such as a servicer who indicated that the 
current regulations do not work because of difficult situations with 
borrowers that arise when payment shock occurs. Every commenter who 
stated a reason for opposing the Make No Change alternative indicated 
that they opposed the alternative because it would not address the 
payment shock problem and/or ignored that a problem exists. There were 
13 commenters who made such a statement--10 originators/servicers 
(including 1 of the 4 mentioned above), 1 trade association, 1 tax 
service, and the home builder mentioned above.
    Countrywide commented that payment shock is the most serious 
problem caused by the existing escrow accounting regulations because it 
leads to delinquency, hurts borrowers' credit, and may result in people 
losing their homes. NationsBank commented that it results in an 
inability to make additional payments in the second year, increases the 
possibility of delinquent payments, and accelerated collection 
proceedings, and causes consumers to lose confidence in their lending 
institutions. Two other originators/servicers agreed with Countrywide's 
assessment that the situation leads to a significant number of defaults 
and foreclosures. Two commenters commented that when payment shock

[[Page 3230]]

occurs, borrowers unfairly blame their lenders and/or their builders 
and closing agents. Two commenters commented that when it happens, 
lenders are left having to carry shortages, sometimes for 24 to 48 
months, and that this puts the lenders at risk. Countrywide indicated 
that it is a particularly perilous situation when two or more risk 
factors are present in a transaction (a condition known as ``layered 
risk''), such as when payment shock is combined with an upward 
adjustment in the ARM rate.
    In contrast, seven originators/servicers questioned whether payment 
shock was really a problem in need of fixing. A bank with a mortgage 
lending subsidiary commented that while many consumers fail to plan for 
payment shock, they are not really surprised by it and feel that the 
problem has nothing to do with the servicer. A rural bank commented 
that it is really a consumer education problem, a problem that will 
happen regardless of whether there is an escrow account or not. A bank 
holding company commented that it is not a significant problem, while a 
federal credit union indicated it was a very infrequent problem. One 
servicer requested that the Department wait until the transition period 
expires on the 1994-1995 escrow rules before making any further 
changes. Citicorp also questioned whether it is a real and on-going 
problem and suggested waiting until 1998 to consider new requirements.
1. Comments on Consumer Choice
    Only one commenter, the California Association of Realtors (CAR), 
supported Consumer Choice. As with the Annual vs. Installment 
Disbursements problem, the CAR commented that it favored approaches 
that provide consumers with as much information as possible and the 
opportunity, when fully informed, to make choices about the servicing 
of their loans and the related impound/escrow accounting.
    In contrast, 81 commenters opposed the adoption of Consumer 
Choice--66 originators/servicers, 10 trade associations, 1 tax service, 
2 financial software companies, 1 builder, and 1 person of unknown 
professional interest. The most common reasons given included:
    1. It would result in miscellaneous costs and/or administrative 
burdens (e.g., would increase cost of servicing or be a burden on 
closing, would create operational problems, would be complicated) (53 
commenters--46 originators/servicers, 5 trade associations, 1 financial 
software company, 1 builder).
    2. It would be impractical (36 commenters), for reasons such as 
servicers will not have or would find it difficult to get or estimate 
the information needed to calculate the disclosure (30 commenters--28 
originators/servicers, 2 financial software companies).
    3. It would necessitate more customer service to explain choices 
and answer questions for consumers (28 commenters--26 originators/
servicers, 2 trade associations).
    4. Consumer Choice would require system and programming changes and 
new software or additional programming (23 commenters--19 originators/
servicers, 4 trade associations). Two large lenders indicated that if 
Consumer Choice were selected they would need in excess of 18 to 24 
months from the issuance of the final rule to reprogram their computers 
and develop new forms and procedures.
    5. The specific costs and burdens of consumer disclosure, including 
producing and mailing disclosures, soliciting preferences, processing 
disclosures, tracking selections, and maintaining information on 
selection should be avoided (19 commenters--12 originators/servicers, 6 
trade associations, 2 financial software companies) or objections to 
adding a new disclosure in general (5 commenters--4 originators/
servicers, 1 builder).
    6. The additional cost would be passed on to consumers (21 
commenters--16 originators/servicers, 3 trade associations, 1 financial 
software company, 1 builder).
    7. It would create consumer confusion, consumers would not be able 
to make an educated selection, and it would impose a burden on 
consumers to have to make such a choice (17 commenters--11 originators/
servicers, 4 trade associations, 1 financial software company, 1 
builder).
    8. There is no need for it (14 commenters) for reasons such that no 
consumer benefit or no significant consumer benefit would result (10 
commenters--6 originators/servicers, 4 trade associations).
    9. It would necessitate multiple sets of closing documents to 
accommodate possible choices or otherwise interfere with the correct 
preparation of closing documents (eight commenters--five originators/
servicers, one trade association, one financial software company, one 
builder).
    10. Additional training of staff would be required (eight 
commenters--six originators/servicers, two trade associations).
    Several commenters commented specifically about the proposed 
prohibition against servicers switching accounting methods without the 
borrower's consent, which was one element of the Consumer Choice 
alternative. Only one commenter, GE Capital, indicated that it 
supported restricting changes to accounting methods when there is a 
transfer of servicing. GE Capital's support, however, was conditioned 
on the selection of the accounting method being limited to a one-time 
choice at closing, the selection being limited to situations involving 
new construction, and the regulations being clarified to provide that 
payments (as opposed to methodology) could be changed in the event of 
unanticipated changes to escrow items.
    In contrast, seven commenters, including six originators/servicers 
and one trade association, opposed the aspect of Consumer Choice 
prohibiting servicers from switching escrow accounting methods. The 
reasons given included the following: (1) It would chill or burden 
sales of servicing rights (three originators/servicers, one trade 
association); (2) it would pose an administrative burden (two 
originators/servicers); and (3) it would impair value of servicing 
rights (two originators/servicers).
    In the proposed rule, the Department asked Question 2, which was 
designed to elicit commenters' views on how to define a substantial 
increase in disbursements from an escrow account, and how mortgage 
servicers could go about determining whether bills paid out of escrow 
accounts were expected to increase substantially after the first year. 
Virtually all of the commenters that responded to this question focused 
on whether a 50 percent increase was an appropriate threshold for 
defining a substantial increase, as proposed.
    Four commenters--three originators/servicers and one trade 
association--supported using 50 percent as a threshold. One bank 
holding company indicated that 50 percent was an appropriate threshold 
but that the payment shock problem should only be addressed in 
situations involving new construction. Most gave no reason for why they 
believed 50 percent was an appropriate threshold, other than that it 
seemed to be a reasonable approach. The National Association of Federal 
Credit Unions (NAFCU) indicated that the approach would avoid 
confusion.
    In contrast, 21 commenters--17 originators/servicers, 2 trade 
associations, 1 financial software

[[Page 3231]]

company, and 1 builder--opposed using 50 percent as a threshold. Many 
of these commenters indicated that the Department should not set any 
threshold for when an increase would be considered substantial, yet no 
commenters favored offering alternatives to borrowers whose escrow 
payments were not expected to increase substantially after the first 
year, and 16 commenters (14 originators/servicers, 2 trade 
associations) specifically opposed such an idea. The reasons for 
opposing using 50 percent as a threshold and/or opposing any 
Department-established threshold were similar. They included:
    1. Servicers would not be able to estimate if the expected increase 
was within the threshold (seven comments--six originators/servicers, 
one trade association).
    2. Even less than a 50 percent increase could be a problem for 
borrowers (five commenters--three originators/servicers, one financial 
software company, one builder).
    3. It would be burdensome and/or costly to calculate if the 
expected increase would meet the threshold (five commenters--four 
originators/servicers, one trade association).
    4. Servicers should be given more flexibility (two originators/
servicers).
    The Department also asked Questions 2 and 7, which were designed to 
elicit responses as to whether, if the Consumer Choice alternative were 
adopted, the final rule should limit a borrower's opportunity to switch 
escrow accounting methods. Sixteen commenters (14 originators/
servicers, 1 trade association, 1 financial software company) indicated 
that they opposed allowing even a one-time choice to be provided to 
consumers, but that if the Department chose the Consumer Choice 
alternative anyway, it should be limited to a one-time choice, for 
reasons such as the additional burdens and costs more opportunities to 
switch would create. Several other commenters that were less clear in 
their dislike of the Consumer Choice alternative, nonetheless took 
clear positions against offering more than a one-time choice.
    In contrast, only three commenters advised against having different 
systems for different borrowers. One based its view on the additional 
confusion it would create over options and management of the options. 
Another based its opinion on the additional complications. A third 
stated it would add to the programming, personal, and postage costs and 
create more confusion.
2. Comments on Make No Change Alternative
    A total of 46 commenters supported the Make No Change alternative. 
Forty-two commenters--35 originators/servicers, 5 trade associations, 1 
financial software company, and 1 person of unknown professional 
interest--supported Make No Change as proposed. The MBA and a bank and 
trust indicated that Make No Change was their second choice next to 
Mandate First Year Overpayment; NAFCU also implied it was their second 
choice.
    Four additional commenters indicated they would support Make No 
Change if Variation (A) were added to it. The proposed rule described 
Variation (A) as follows:

    (A) Require servicers to disclose to borrowers that it is 
anticipated that they will have a substantial payment increase in 
the second year, so borrowers will be less surprised when such an 
increase occurs, but do not require servicers to indicate 
specifically to borrowers methods of avoiding the shortage.

61 FR 46517.
    Three of the 42 who supported the Make No Change alternative as 
proposed also indicated they would support Make No Change with 
Variation (A). In addition, two originators/servicers that recommended 
alternatives instead of Make No Change also indicated that as part of 
those approaches that it should be disclosed to the borrower that a 
shortage is expected, but not the amount of the expected shortage.
    One commenter who otherwise supported the Make No Change 
alternative indicated that it was opposed to mandating any type of 
notice, but indicated a notice similar to Variation (A) would be less 
problematic than the type of disclosure that would be part of the 
Consumer Choice alternative. The commenter observed that any disclosure 
should be generic (no calculations) and advise consumers that: (1) The 
amount of taxes for which escrow funds are being collected is based on 
information available at time of closing about anticipated property 
taxes for next year; (2) the amount could change especially for new 
construction; and (3) the consumer should monitor the situation and 
consult a tax advisor if the amount increases substantially.
    Ten other commenters--eight originators/servicers, one financial 
software company, one builder--specifically commented that they opposed 
Variation (A). The primary reasons were that it would not be effective 
at eliminating payment shock, and giving borrowers advance notice that 
a payment increase may occur should be left to the originator/servicer. 
The reasons the commenters gave for supporting the Make No Change 
alternative as their second choice were similar to the reasons other 
commenters gave for supporting it as their first choice. The reasons of 
all the commenters who supported it as their first or second choice are 
summarized below:
    1. This approach would encourage good, voluntary practices to help 
customers on an individual basis (25 commenters--22 originators/
servicers, 3 trade associations).
    2. No change is needed because the current rule is adequate (four 
commenters--three originators/servicers, one financial software 
company).
    3. It would not be disruptive (three commenters--two originators/
servicers, one trade association).
    4. It would allow servicers to exercise good judgment (two trade 
associations).
    5. It would be flexible (two originators/servicers).
    6. Providing consumers with a simple disclosure would give 
consumers information to act in their own best interest (one trade 
association).
    In contrast, 13 commenters--10 originators/servicers, 1 trade 
association, 1 tax service, and 1 builder--opposed the Make No Change 
alternative. Each of these commenters stated that they opposed the 
alternative because it would not address the problem and/or ignored a 
problem that exists.
    Other commenters supported other variations on the Make No Change 
alternative. Two originators/servicers supported Variation (B). 
Variation (B) would have required servicers to disclose to borrowers 
that it is anticipated that they will have a substantial payment 
increase in the second year, and to inform borrowers of the amount of 
the expected shortage at the end of the first year and of the 
opportunity to make additional payments to escrow ahead of schedule to 
avoid payment shock. On the other hand, seven commenters--five 
originators/servicers and two financial software companies--opposed 
Variation (B) for reasons such as the burdens and difficulties 
associated with trying to estimate the amount of a shortage that is 
expected to result.
    In the proposed rule the Department also solicited comments on the 
following alternative. For each new account for which it is anticipated 
that there will be a substantial payment increase in the second year 
for one or

[[Page 3232]]

more escrow items, allow the servicer, with the consent of the 
borrower, the option of calculating the escrow payments on a 24-month 
basis. This would allow the servicer to look ahead to the second year 
and estimate the payment that would be due, thereby mitigating the 
deficiency or shortage after the first year, leaving a smaller 
deficiency or shortage after the second year. (Using an escrow account 
period of more than 1 year has precedent. See the treatment of flood 
insurance and water purification escrow funds in Sec. 3500.17(c)(9).) 
Under this option, since the amounts held in escrow would be greater 
than allowed under section 10 of RESPA, it would be necessary for the 
Secretary to invoke his exemption authority under section 19(a) of 
RESPA (12 U.S.C. 2617).
    Only eight commenters commented on this particular approach. Five 
commenters supported it while three opposed it. The Department does not 
believe it is a superior approach to that adopted in this final rule, 
as discussed below.
    The proposed rule also invited commenters to submit other 
permissible approaches under RESPA that would better serve the 
interests of the public and the intent of the statute, inviting 
commenters to submit specific regulatory language to implement their 
proposals. Fourteen originators/servicers and two trade associations 
submitted a variety of additional alternatives, none of which appear to 
the Department to be a superior approach to that adopted in this final 
rule, as discussed below.
3. Comments on Mandate First Year Overpayment Alternative
    Twenty-seven commenters--21 originators/servicers, 2 trade 
associations, 2 financial software companies, 1 tax service, and 1 
State lending agency--supported the Mandate First Year Overpayment 
alternative. In addition, Citicorp indicated that the Mandate First 
Year Overpayment alternative was its second choice to the Make No 
Change alternative. Bank of America indicated it was its second choice 
next to an alternative of its own creation, but only for new 
construction and situations involving special tax discounts (e.g., 
reduced taxes for seniors, disabled, or veterans). GE Capital indicated 
it was its second choice to the Make No Change alternative, but should 
only apply if the increase will be due to taxes being based on the land 
value only for the first year. If the increase will be due to items 
paid prior to the first payment date, GE Capital favored a different 
approach.
    The reasons given for supporting the Mandate First Year Overpayment 
alternative included the following:
    1. This approach would avoid payment shock best and would result in 
the fewest shortages (14 commenters--11 originators/servicers, 2 trade 
associations, 1 financial software company).
    2. It would be better for consumers (12 commenters--9 originators/
servicers, 2 financial software companies, 1 State lending agency).
    3. It would increase consistency, standardization, and uniformity 
(seven commenters--three originators/servicers, one trade association, 
two financial software companies, one State lending agency).
    4. It would require only minimal changes (four commenters--two 
originators/servicers, two financial software companies).
    5. It would be the least costly alternative to implement (one 
originator/servicer, one financial software company).
    6. It would be the fairest alternative (one originator/servicer, 
one tax service).
    In contrast, 36 commenters--32 originators/servicers, 3 trade 
associations, and 1 person of unknown professional interest--opposed 
the Mandate First Year Overpayment alternative. The reasons given for 
opposing this alternative included the following:
    1. It would not be in the consumer's interest to overpay and then 
money get back; this would be unfair to the borrower (10 commenters--7 
originators/servicers, 2 trade associations, 1 person of unknown 
professional interest).
    2. This alternative would be administratively burdensome or costly 
(e.g., having to make constant refunds and explanations to consumer) 
(six commenters--four originators/servicers, two trade associations).
    3. It would run contrary to the Secretary's stated objectives (21 
originators/servicers).
    In the proposed rule, the Department proposed that as a variation 
on Method C, the cushion could be calculated as one-sixth of the 
estimated annual disbursements for the first year, instead of 2 months 
of the escrow payments for the first year. Two originators/servicers 
and a financial software company indicated that they preferred Method C 
to the variation. One of these commenters, a bank holding company, 
indicated that the variation would be far less effective at eliminating 
payment shock, while another, a mortgage company, indicated the 
variation would be more complicated for borrowers and for the industry. 
No commenter indicated a preference for the variation.
    Commenters also suggested several additional variations on the 
Mandate First Year Overpayment alternative as their preferred approach, 
such as limiting it only to situations involving new construction (five 
commenters--four originators/servicers, one trade association) or 
offering it even when less than a 50 percent increase in disbursements 
were expected (four commenters--two originators/servicers, one 
financial software company, one builder).

B. Approach Adopted in Today's Final Rule

    Based on the comments received, the Secretary has determined that 
there would be little value in rulemaking on the payment shock 
``problem.'' The comments, in sum, do not indicate that the ``problem'' 
is uniformly accepted as such in the industry, there is little support 
for the Department's prescribing a particular accounting method that 
will result in overescrowing consumers' money, and there is no 
agreement on the nature of any form that the Department would prescribe 
for homebuyers to warn of the possibility of a substantial increase in 
payments to their accounts.
    During the rulemaking, however, the Department identified that 
individual servicers do provide a written disclosure to borrowers when 
they anticipate increased payments. The Department favors this approach 
and believes that such a disclosure should be encouraged as a best 
practice, without the Department prescribing the particular form.
    The Department has decided to adopt, with modifications, the Make 
No Change alternative. This final rule, therefore, continues the 
current requirements for escrow analysis, even when the servicer 
expects that the disbursements from the escrow account will increase 
substantially after the first year. This alternative will not prevent 
payment shock in all instances. Under the final rule, however, as in 
the past, servicers may disclose the problem to borrowers, and 
borrowers may make voluntary overpayments to escrow accounts. Servicers 
may also calculate short-year statements. Thus, some methods are 
available to alleviate the payment shock problem, although they are not 
required.
    This final rule does depart, however, from the Make No Change 
alternative of the proposed rule in encouraging, on a voluntary basis, 
the use of a consumer disclosure format concerning payment shock to be 
given to consumers when

[[Page 3233]]

the originator or servicer expects that a substantial increase in 
escrow payments will occur in the second year of the escrow account. 
The Department has determined not to define a ``substantial increase.'' 
Instead, this rule leaves this determination to each originator or 
servicer to apply sound business judgment.
    This disclosure format, which is published as an appendix to this 
final rule, will be available from the Department as a Public Guidance 
Document at the address indicated in 24 CFR 3500.3. The format is 
entitled ``Consumer Disclosure for Voluntary Escrow Payments'' to 
clarify that when the originator or servicer provides the disclosure, 
the consumer may choose whether to make higher payments during the 
first year to reduce or eliminate the monthly payment increase in the 
second year. The disclosure contains the following information:

    The bills paid out of your escrow account are expected to 
increase substantially after the first year[.] [because 
______________]. Under normal escrow practices, your monthly escrow 
payment in the second year could be much higher than in the first.
    You may voluntarily choose to make higher payments during the 
first year to reduce or eliminate the monthly payment increase in 
the second year. If you are interested in doing this, contact:
----------------------------------------------------------------------

    The instructions to the preparer explain that the blank provided is 
to indicate whom to contact for further information on making voluntary 
overpayments during the first year, including the mailing address, fax 
number, e-mail address, and/or telephone number of the contact. The 
terms ``reserve'' or ``impound'' may be substituted for the terms 
``escrow account'' or ``escrow'' to reflect local usage.
    While use of the disclosure is not mandatory, providing the 
disclosure to consumers is a best practice that the Department 
encourages originators and servicers to follow. The Department is 
publishing this format at the end of this rule as an appendix for the 
convenience of the reader. It will not be codified in the Code of 
Federal Regulations.
    The recommended format published with this final rule, in addition 
to providing notice that payment shock may occur, also indicates that 
payment shock can be avoided by making additional payments to the 
escrow account, and suggests that the consumer ask the appropriate 
originator or servicer for more information. While simply informing 
consumers of the potential of payment shock and providing information 
on how to avoid it may not lead the consumers to take actions to avoid 
it, the information will benefit some consumers and may lead them to 
request voluntary borrower and servicer agreements to make additional 
payments to avoid shortages.
    To provide clarity to servicers, this rule adds a new provision (24 
CFR 3500.17(f)(2)(iii)) regarding funds deposited as a result of such 
voluntary borrower and servicer agreements. The provision states that 
the voluntary agreement is for a 1-escrow-account-year period, although 
successive agreements are allowed. By receiving higher escrow payments 
into the account, the ending balance will be greater, thus lowering or 
eliminating the anticipated shortage at the time of the next analysis. 
At the time of the next escrow analysis, Sec. 3500.17(f) regarding 
shortages, surpluses, and deficiencies will continue to apply, and may 
not be changed by any voluntary agreement.

C. Basis for Approach Adopted

    The comments received served to confirm that the Make No Change 
alternative, with some modifications, is a workable solution to this 
problem. Based on its review of the comments, the costs and burdens 
associated with any other approach are simply too great compared to the 
benefits. There is no strong evidence that additional regulation is 
needed at this time to address the problem. Existing procedures are 
adequate to avoid payment shock. This rule encourages originators and 
servicers to inform consumers of the potential problem and allow them 
to use existing procedures to avoid the problem if they so desire.
    This final rule is similar to Variation (A) of the Make No Change 
alternative in the proposed rule, which was recommended by several 
commenters. As recommended by commenters, use of the format is not 
mandatory, but the recommended format is similar to that which was 
suggested by several commenters. Heeding the objections of several 
commenters, the recommended format does not call for an estimate of the 
amount of a shortage that is expected to result. Several commenters 
urged that the final rule leave the decision of whether to give 
borrowers advance notice that a payment increase may occur to the 
originator/servicer. In response, this final rule leaves this 
determination to each originator or servicer to apply sound business 
judgment in deciding whether to provide the disclosure; it does not 
make the disclosure mandatory or define a ``substantial increase.''
    The Department intends this final rule to encourage more 
originators and servicers to adopt practices that will ensure that 
consumers are informed of the payment shock problem and given the 
opportunity to avoid it. These practices include:
     Notifying borrowers in advance and providing an 
opportunity to make voluntary payments ahead of schedule to avoid 
payment shock. The Department encourages servicers to use the 
recommended format published today to notify borrowers of this 
potential problem when the originator or servicer, in applying sound 
business judgment, believes that payment shock is like to occur.
     Offering consumers extended repayment plans, even beyond 
those required under RESPA, to make up substantial shortages associated 
with payment shock.
    These two practices are examples of the types of best practices 
that some originators/servicers in the industry are using today, even 
without a Government requirement. The Department encourages servicers 
to adopt these practices so that they will become more widespread.

D. Basis for Rejecting Alternative Approaches

1. Rejection of Consumer Choice Alternative
    While the Department believes it would have legal authority to 
impose Consumer Choice, including the prohibition against the servicer 
changing escrow account methods, as part of the Secretary's rulemaking 
authority, it has decided not to do so. The types of costs and burdens 
associated with such an approach are prohibitive at this time.
    The Department was also influenced by the obvious lack of consensus 
among the commenters as to how to work out the technical details 
associated with the Consumer Choice alternative. The Department asked 
several specific questions about how to go about implementing such an 
alternative in the way least disruptive to the industry. The answers 
reflected the uncertainties and disruptions that would be created by 
imposing the Consumer Choice alternative, and helped convince the 
Department that such an approach is not feasible. Since the Department 
is not adopting the Consumer Choice alternative in this final rule, the 
responses received to a number of the questions raised in the proposed 
rule concerning this issue do not merit detailed discussion, but a 
brief summary of the comments in response to these questions is 
provided below to give a

[[Page 3234]]

sense of the divergent opinions received:
    1. The Department asked Question 5, which was designed to elicit 
views on when the appropriate time would be for the originator or 
servicer to provide the borrower the disclosure, if the Consumer Choice 
alternative were to be adopted. The commenters were nearly evenly 
divided on whether the disclosure should be provided and the selection 
made before closing but after underwriting or before underwriting. 
Eight commenters simply indicated sometime before closing, whereas six 
commenters indicated that it would have to be before underwriting. Two 
originators/servicers and one tax service indicated that no matter what 
time was selected, problems would arise. Five commenters specifically 
indicated that the selection would affect underwriting because it could 
affect the funds needed to close, whereas one mortgage lending 
subsidiary of a bank stated emphatically that it ``should have 
absolutely no bearing on the loan underwriting or approval process 
since the borrower must qualify based on a tax escrow payment 
calculated on fully assessed value.''
    2. The Department asked Question 6, which asked whether the 
Department should prescribe a disclosure format if an approach were 
adopted in which the borrower's preference for a particular escrow 
accounting method were controlling. Although there was general 
agreement that the Department should prescribe the format (15 
commenters supporting prescribing it with only 2 opposed), there was 
disagreement over what the disclosure should say. One commenter 
supported the disclosure the Department had proposed, agreeing ``with 
the simplicity of the proposed format.'' Seven commenters, however, 
said it was confusing and contained too much information, whereas two 
commenters criticized it for not including enough information.
2. Rejection of Mandate First Year Overpayment Alternative
    While the Mandate First Year Overpayment alternative was extolled 
by some in the industry as the best solution, there was no consensus 
even within the industry for this approach. Thirty-two originators/
servicers and 3 trade associations opposed it, while only 21 
originators/servicers, 2 trade associations, 2 financial software 
companies, 1 tax service, and 1 State lending agency supported it. The 
Department is persuaded that it is simply not in the consumer's 
interest to mandate overpayment into escrow accounts, even if consumers 
ultimately get the money back. Mandating escrowing beyond the 
limitations of the statute would be unfair to borrowers. Consumers 
should not be forced to tie up money unnecessarily in their escrow 
accounts and may prefer to invest the money elsewhere or use it for 
other more pressing purposes. There is no compelling case for the 
Department to exercise its exemption authority for this purpose. Nor 
would such an approach be consistent with the Secretary's stated 
objectives for escrow accounting.

VII. Single-Item Analysis With Aggregate Adjustment Problem--Comments 
Received, Approach Adopted in This Final Rule, and Basis

A. Comments Received on Revision Proposed

    The Department sought comments from the public on this proposal, as 
well as other approaches that would be permissible under RESPA and 
might better serve the interests of the public and the intent of the 
statute. The Department also invited commenters to submit specific 
regulatory language to implement their proposals.
    A significant number of commenters, including servicers and trade 
associations, found the proposal to represent a functional or 
acceptable solution. The MBA, while favoring the proposal, indicated 
that some of its members were concerned about settlement agent 
confusion from the change. Those members opposing the change indicated 
that they make use of the 45-day period within which the initial 
analysis must be delivered, so they did not share the concern over 
presenting two different accounting methods. During the Department's 
development of the proposed rule, Federal Reserve Board staff had 
indicated that it had no objection to the approach in the proposed 
rule, inasmuch as the PMI number for APR calculations would otherwise 
be available.
    On the other hand, a number of major lenders and/or servicers 
opposed the change. For example, Chase Mortgage stated that it was not 
beneficial for consumers or servicers, since consumers would lose the 
ease of a single statement from which amounts can be reconciled, and 
servicers would have no viable audit trail to indicate how the initial 
deposit was calculated to resolve later differences or discrepancies. 
Bank of America's comments were similar. A number of other commenters 
decried a retreat from uniformity (the original premise of the 1994-
1995 escrow rules) that allowing options among servicers would produce, 
and indicated that options affected the ease of servicing transfers. On 
a tangential point, the American Escrow Association wanted continued 
clarity that the settlement agent action reflected instructions 
received, not independent activities of the settlement agent.

B. Approach Adopted in This Final Rule and Basis

    The Department carefully reviewed the comments and considered them 
in view of the mandate issued to the Department and the Federal Reserve 
Board under legislation enacted September 30, 1996 to re-examine RESPA 
and TILA disclosure requirements. See sec. 2101 of the Economic Growth 
and Regulatory Paperwork Reduction Act of 1996 (Title II of the Omnibus 
Consolidated Appropriations Act, 1997, Pub. L. 104-208; approved 
September 30, 1996).
    It would be inappropriate to undertake a piecemeal and unilateral 
revision of the HUD-1 and HUD-1A at this time. In addition, the 
elimination of the aggregate adjustment from the HUD-1 and HUD-1A would 
harm those who have already developed systems that rely on it for an 
audit trail. There simply was no consensus for the change. Therefore, 
this final rule does not contain any revision to the 1000 series 
disclosures; servicers should continue to follow existing requirements.
    On a related matter, this rule adds information to the footnote 
instructions to Appendix C, in order to reaffirm a previous 
clarification that instead of using aggregate accounting with no more 
than a 2-month cushion, the reserves on the Good Faith Estimate may be 
estimated by using single item accounting with no more than a 1-month 
cushion (see 61 FR 46518, column 3, September 3, 1996).

VIII. Lead-Based Paint Disclosure Issue--Comments Received, Approach 
Adopted in This Final Rule, and Basis

A. Comments Received on Revision Proposed

    Commenters were almost evenly divided regarding the desirability of 
adding the lead-based paint disclosures. Nine commenters--four 
originators/servicers and five trade associations--indicated that they 
supported or had no objection to the proposal. Most gave no reason. 
Among those who did, the National Association of Federal Credit Unions 
indicated that they supported the proposal because it would help 
educate borrowers of their rights.
    In contrast, eight originators/servicers opposed the proposal. One 
lender indicated that by imposing the burden

[[Page 3235]]

of disclosure on the lender, the Department would be blurring the 
responsibility of sellers to give lead-based paint disclosures required 
by the EPA/HUD rule (implementing section 1018 of the Housing and 
Community Development Act of 1992). The commenter noted that lenders 
have never been required to disclose matters of law between sellers and 
buyers. Six other originators/servicers presented similar or related 
arguments.
    Four originators/servicers indicated that providing a disclosure on 
the GFE would be duplicative of other lead disclosures; one commented 
that the HUD booklet ``Settlement Costs and You'' was a more 
appropriate forum for this type of disclosure. Two originators/
servicers expressed concern that lenders would become involved in 
lawsuits involving lead-based paint, and that the disclosure could be 
interpreted as implying a lender duty in some future consumer class 
action.

B. Approach Adopted in This Final Rule and Basis

    Upon careful review of these comments, the Department agrees with 
the commenters who believe that the lead-based paint disclosure need 
not specifically be added to the GFE and the HUD-1 and HUD-1A as a 
separate line at this time. This final rule continues the existing 
requirement that the lead-based paint inspection fee be included on the 
HUD-1 or HUD-1A if a lead-based paint inspection is either: (1) 
required by the lender, whether paid outside of settlement (in which 
case ``P.O.C.'' should be used) or at settlement; or (2) paid for at 
settlement. The only change made by this rule is a clarification to the 
instructions for the HUD-1. The current instructions indicate that 
Lines 1301 and 1302 of the HUD-1 may be used for ``fees for survey, 
pest inspection, radon inspection, lead-based paint inspection, or 
other similar inspections.'' The instructions are being changed to 
indicate that Lines 1301-1302 or any other available blank line in the 
1300 series may be used for these purposes.
    In addition, the Department has recently implemented several 
programs to assist homebuyers in financing the cost of lead-based paint 
inspections, risk assessments, and repairs. These programs include 
special requirements for the disclosure of information pertaining to 
lead-based paint on the HUD-1 and HUD-1A, which were explained in 
Notice H 96-93 (HUD) issued by the Department's Office of Housing on 
November 5, 1996.
    Most importantly, since the time the September 13, 1996 proposed 
rule was issued, the Department has replaced its out-of-date settlement 
costs booklet (see 62 FR 31891, June 11, 1997). This new booklet is 
also available on the RESPA Website: http://www.hud.gov/fha/res/
respa__hm.html. This revised booklet discusses the legal provisions 
that allow the buyer the option of obtaining a lead-based paint 
inspection, and gives an earlier and more meaningful description of the 
lead-based paint inspection process to the consumer. The Department is 
also currently engaged in a process with the Federal Reserve Board, 
referred to in Part VII(B) above of this preamble, which involves an 
overall review of settlement disclosure forms and requirements.

IX. Rule Changes

    The changes made in this final rule are summarized below:
    1. This rule amends Sec. 3500.17(a) to include a reference to the 
voluntary disclosure format. This reference clarifies that the 
Department encourages, but does not require, originators and servicers 
to provide the format to consumers when they anticipate a substantial 
increase in disbursements from the escrow account after the first year 
of the loan.
    2. This rule revises the definition of ``disbursement date'' in 
Sec. 3500.17(b) to eliminate a redundant sentence that had referred to 
Sec. 3500.17(k).
    3. This rule adds a definition of ``penalty'' to Sec. 3500.17(b) to 
clarify that a penalty does not include any additional charge or fee 
associated with choosing installment payments as opposed to annual 
payments or for choosing one installment plan over another. As 
discussed in Part III(C)(1) of this preamble, this new definition is 
necessary to clarify, in response to comments on the proposed rule, 
that a service fee levied by the payee on installment payments is not 
regarded as a penalty.
    4. This rule amends Sec. 3500.17 (c)(1) and (c)(2) to eliminate 
redundant descriptions of the requirements of Sec. 3500.17(k); the 
requirements of Sec. 3500.17(k) are clarified by revisions to that 
paragraph. This rule also makes technical amendments to the citation of 
Sec. 3500.17 (c)(1) and (c)(2).
    5. This rule revises Sec. 3500.17(i)(1) to conform the language 
more closely to the statutory language in section 10(c)(2)(A) of RESPA. 
While this clarification pertains to escrow accounting, it does not 
directly relate to the other matters addressed in this final rule. This 
is a technical clarification, not a departure from prior requirements. 
As such, the Department restates its position that because an escrow 
account statement clearly itemizes all amounts paid out of the escrow 
account during the period as required, the statement does not also have 
to provide, as an additional element of the statement, a separate sum 
of all of those amounts.
    6. This rule revises Sec. 3500.17 (k)(1) and (k)(2) to eliminate 
awkward and unnecessary cross-references to the definition of 
``disbursement date.'' The revisions to paragraph (k)(1) eliminate 
language that had indicated that in calculating the disbursement date, 
servicers were to use a date on or before the earlier of the deadline 
to take advantage of discounts, if available, or the deadline to avoid 
a penalty. This language caused much public confusion. Instead, as 
explained in Part III(C)(1) of this preamble, under this final rule 
servicers are required to disburse in a timely manner, that is, on or 
before the deadline to avoid a penalty. For escrow items other than 
property taxes, the rule leaves it to the servicer to decide whether to 
disburse on a date early enough to take advantage of discounts, so long 
as the disbursement basis (annual or installments) and the disbursement 
date complies with the normal lending practice of the lender and local 
custom and constitutes prudent lending practice. For property taxes 
only, this rule contains special requirements in paragraph (k)(3).
    7. This rule adds Sec. 3500.17(k)(3) to specify the special 
additional requirements applicable to property taxes when the taxing 
jurisdiction offers the servicer a choice of disbursements on an 
installment or annual basis. Those requirements are explained in Part 
III(C)(1) of this preamble.
    8. This rule adds Sec. 3500.17(k)(4) to specify that a servicer and 
borrower may mutually agree, on an individual case basis, to a 
different disbursement basis (installment or annual) or disbursement 
date for property taxes, so long as their agreement avoids a penalty, 
complies with the normal lending practice of the lender and local 
custom, and constitutes prudent lending practice. This provision is 
discussed in Part III(C)(1) of this preamble.
    9. This rule makes one minor clarification to the instructions to 
the HUD-1 as it relates to disclosure of ``lead-based paint 
inspection'' fees.
    10. This rule includes as an appendix a voluntary disclosure format 
that is entitled ``Consumer Disclosure for Voluntary Escrow Account 
Payments.'' This format is discussed in Part IV(C)(1) of this preamble.
    11. This rule adds a footnote instruction to Appendix C to part 
3500, the Sample Form of Good Faith

[[Page 3236]]

Estimate, to clarify that single item analysis with a 1-month cushion 
can be used in developing the estimates for reserves relating to lines 
1000-1005 of the Good Faith Estimate.

Findings and Certifications

Paperwork Reduction Act

    The information collection requirements in this final rule have 
been approved by the Office of Management and Budget (OMB) in 
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-
3520), and assigned OMB control number 2502-0517. An agency may not 
conduct or sponsor, and a person is not required to respond to, a 
collection of information unless the collection displays a valid 
control number.

Environmental Impact

    In accordance with 24 CFR 50.19(c)(1) of the Department's 
regulations, this rule does not direct, provide for assistance or loan 
and mortgage insurance for, or otherwise govern or regulate property 
acquisition, disposition, lease, rehabilitation, alteration, 
demolition, or new construction, or set out or provide for standards 
for construction or construction materials, manufactured housing, or 
occupancy. Therefore, this rule is categorically excluded from the 
requirements of the National Environmental Policy Act (42 U.S.C. 4321).

Executive Order 12866

    The Office of Management and Budget (OMB) reviewed this rule under 
Executive Order 12866, Regulatory Planning and Review, issued by the 
President on September 30, 1993. OMB determined that this rule is a 
``significant regulatory action,'' as defined in section 3(f) of the 
Order (although not economically significant, as provided in section 
3(f)(1) of the Order). Any changes made in this rule subsequent to its 
submission to OMB are identified in the docket file, which is available 
for public inspection between 7:30 a.m. and 5:30 p.m. in the Office of 
the Rules Docket Clerk, Office of General Counsel, Room 10276, 
Department of Housing and Urban Development, 451 Seventh Street, SW, 
Washington, DC.

Regulatory Flexibility Act

    The Secretary, in accordance with the Regulatory Flexibility Act (5 
U.S.C. 605(b)), has reviewed this rule before publication and by 
approving it certifies that this rule would not have a significant 
economic impact on a substantial number of small entities. This rule 
will maintain existing requirements, but clarify them. It also 
recommends voluntary use of certain practices that would benefit 
consumers, including voluntary use of a model disclosure format.

Executive Order 12612, Federalism

    The General Counsel, as the Designated Official under section 6(a) 
of Executive Order 12612, Federalism, has determined that the policies 
contained in this rule would not have substantial direct effects on 
States or their political subdivisions, or the relationship between the 
Federal Government and the States, or on the distribution of power and 
responsibilities among the various levels of government. As a result, 
the rule is not subject to review under the Order. The rule is directed 
toward clarifying existing requirements and encouraging voluntary use 
of certain practices that the Department believes would be beneficial 
to consumers.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 (UMRA) (Pub. 
L. 104-4; approved March 22, 1995), establishes requirements for 
Federal agencies to assess the effects of their regulatory actions on 
State, local, and tribal governments, and on the private sector. This 
rule does not impose any Federal mandates on any State, local, or 
tribal governments, or on the private sector, within the meaning of the 
UMRA.

List of Subjects in 24 CFR Part 3500

    Consumer protection, Condominiums, Housing, Mortgages, Mortgage 
servicing, Reporting and recordkeeping requirements.

    For the reasons stated in the preamble, part 3500 of title 24 of 
the Code of Federal Regulations is amended as set forth below.

PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT

    1. The authority citation is revised to read as follows:

    Authority: 12 U.S.C. 2601 et seq.; 42 U.S.C. 3535(d).

    2. In Sec. 3500.17:
    a. Paragraph (a) is amended by adding a sentence at the end;
    b. Paragraph (b) is amended by revising the definition of 
``Disbursement date'', and by adding a new definition of ``Penalty'' in 
alphabetical order;
    c. Paragraphs (c)(2) and (c)(3) are revised;
    d. Paragraph (f) is amended by adding a new paragraph (f)(2)(iii);
    e. Paragraph (i) is amended by revising the third sentence of the 
introductory text of paragraph (i)(1) and by revising paragraph 
(i)(1)(iv); and
    f. Paragraph (k) is revised, to read as follows:


Sec. 3500.17  Escrow accounts.

    (a) * * * A HUD Public Guidance Document entitled ``Consumer 
Disclosure for Voluntary Escrow Account Payments'' provides a model 
disclosure format that originators and servicers are encouraged, but 
not required, to provide to consumers when the originator or servicer 
anticipates a substantial increase in disbursements from the escrow 
account after the first year of the loan. The disclosures in that model 
format may be combined with or included in the Initial Escrow Account 
Statement required in Sec. 3500.17(g).
    (b) * * *
* * * * *
    Disbursement date means the date on which the servicer actually 
pays an escrow item from the escrow account.
* * * * *
    Penalty means a late charge imposed by the payee for paying after 
the disbursement is due. It does not include any additional charge or 
fee imposed by the payee associated with choosing installment payments 
as opposed to annual payments or for choosing one installment plan over 
another.
* * * * *
    (c) * * *
    (2) Escrow analysis at creation of escrow account. Before 
establishing an escrow account, the servicer must conduct an escrow 
account analysis to determine the amount the borrower must deposit into 
the escrow account (subject to the limitations of paragraph (c)(1)(i) 
of this section), and the amount of the borrower's periodic payments 
into the escrow account (subject to the limitations of paragraph 
(c)(1)(ii) of this section). In conducting the escrow account analysis, 
the servicer must estimate the disbursement amounts according to 
paragraph (c)(7) of this section. Pursuant to paragraph (k) of this 
section, the servicer must use a date on or before the deadline to 
avoid a penalty as the disbursement date for the escrow item and comply 
with any other requirements of paragraph (k) of this section. Upon 
completing the initial escrow account analysis, the servicer must 
prepare and deliver an initial escrow account statement to the 
borrower, as set forth in paragraph (g) of this section. The servicer 
must use the escrow account analysis to determine whether a surplus, 
shortage, or deficiency exists and must make any

[[Page 3237]]

adjustments to the account pursuant to paragraph (f) of this section.
    (3) Subsequent escrow account analyses. For each escrow account, 
the servicer must conduct an escrow account analysis at the completion 
of the escrow account computation year to determine the borrower's 
monthly escrow account payments for the next computation year, subject 
to the limitations of paragraph (c)(1)(ii) of this section. In 
conducting the escrow account analysis, the servicer must estimate the 
disbursement amounts according to paragraph (c)(7) of this section. 
Pursuant to paragraph (k) of this section, the servicer must use a date 
on or before the deadline to avoid a penalty as the disbursement date 
for the escrow item and comply with any other requirements of paragraph 
(k) of this section. The servicer must use the escrow account analysis 
to determine whether a surplus, shortage, or deficiency exists, and 
must make any adjustments to the account pursuant to paragraph (f) of 
this section. Upon completing an escrow account analysis, the servicer 
must prepare and submit an annual escrow account statement to the 
borrower, as set forth in paragraph (i) of this section.
* * * * *
    (f) * * *
    (2) * * *
    (iii) After an initial or annual escrow analysis has been 
performed, the servicer and the borrower may enter into a voluntary 
agreement for the forthcoming escrow accounting year for the borrower 
to deposit funds into the escrow account for that year greater than the 
limits established under paragraph (c) of this section. Such an 
agreement shall cover only one escrow accounting year, but a new 
voluntary agreement may be entered into after the next escrow analysis 
is performed. The voluntary agreement may not alter how surpluses are 
to be treated when the next escrow analysis is performed at the end of 
the escrow accounting year covered by the voluntary agreement.
* * * * *
    (i) * * *
    (1) * * * The annual escrow account statement must include, at a 
minimum, the following (the items in paragraphs (i)(1)(i) through 
(i)(1)(iv) must be clearly itemized):
* * * * *
    (iv) The total amount paid out of the escrow account during the 
same period for taxes, insurance premiums, and other charges (as 
separately identified);
* * * * *
    (k) Timely payments. (1) If the terms of any federally related 
mortgage loan require the borrower to make payments to an escrow 
account, the servicer must pay the disbursements in a timely manner, 
that is, on or before the deadline to avoid a penalty, as long as the 
borrower's payment is not more than 30 days overdue.
    (2) The servicer must advance funds to make disbursements in a 
timely manner as long as the borrower's payment is not more than 30 
days overdue. Upon advancing funds to pay a disbursement, the servicer 
may seek repayment from the borrower for the deficiency pursuant to 
paragraph (f) of this section.
    (3) For the payment of property taxes from the escrow account, if a 
taxing jurisdiction offers a servicer a choice between annual and 
installment disbursements, the servicer must also comply with this 
paragraph (k)(3). If the taxing jurisdiction neither offers a discount 
for disbursements on a lump sum annual basis nor imposes any additional 
charge or fee for installment disbursements, the servicer must make 
disbursements on an installment basis. If, however, the taxing 
jurisdiction offers a discount for disbursements on a lump sum annual 
basis or imposes any additional charge or fee for installment 
disbursements, the servicer may at the servicer's discretion (but is 
not required by RESPA to), make lump sum annual disbursements in order 
to take advantage of the discount for the borrower or avoid the 
additional charge or fee for installments, as long as such method of 
disbursement complies with paragraphs (k)(1) and (k)(2) of this 
section. HUD encourages, but does not require, the servicer to follow 
the preference of the borrower, if such preference is known to the 
servicer.
    (4) Notwithstanding paragraph (k)(3) of this section, a servicer 
and borrower may mutually agree, on an individual case basis, to a 
different disbursement basis (installment or annual) or disbursement 
date for property taxes from that required under paragraph (k)(3) of 
this section, so long as the agreement meets the requirements of 
paragraphs (k)(1) and (k)(2) of this section. The borrower must 
voluntarily agree; neither loan approval nor any term of the loan may 
be conditioned on the borrower's agreeing to a different disbursement 
basis or disbursement date.
* * * * *
    3. In Appendix A to part 3500, under the text heading ``Line Item 
Instructions'', and under the subheading ``Section L. Settlement 
Charges'', the paragraph beginning with the phrase ``Lines 1301 and 
1302'' is revised to read as follows:

Appendix A to Part 3500--Instructions for Completing HUD-1 and HUD-
1A Settlement Statements; Sample HUD-1 and HUD-1A Statements

* * * * *

Line Item Instructions

* * * * *

Section L. Settlement Charges

* * * * *
    Lines 1301 and 1302, or any other available blank line in the 
1300 series, are used for fees for survey, pest inspection, radon 
inspection, lead-based paint inspection, or other similar 
inspections.
* * * * *
    4. Appendix C to part 3500 is amended by adding a new footnote 3 
after the word ``Reserves'' in the first column of the table, and by 
adding the following text under the heading ``FOOTNOTES'' at the end 
after the text of footnote 2, to read as follows:

Appendix C to Part 3500--Sample Form of Good Faith Estimate

* * * * *

Footnotes

* * * * *
    \3\ As an alternative to using aggregate accounting with no more 
than a two-month cushion, the estimate may be obtained by using 
single-item accounting with no more than a one-month cushion.

    Dated: January 13, 1998.
Nicolas P. Retsinas,
Assistant Secretary for Housing-Federal Housing Commissioner.

    The following Appendix, ``Public Guidance Document, Consumer 
Disclosure for Voluntary Escrow Account Payments'', will not be 
codified in title 24 of the Code of Federal Regulations.

Appendix

Public Guidance Document

Consumer Disclosure for Voluntary Escrow Account Payments

    The bills paid out of your escrow account are expected to 
increase substantially after the first year[.] [because ________ .] 
Under normal escrow practices, your monthly escrow payment in the 
second year could be much higher than in the first.
    You may voluntarily choose to make higher payments during the 
first year to reduce or eliminate the monthly payment increase in 
the second year. If you are interested in doing this, contact: 
______________________.

[INSTRUCTIONS TO PREPARER: You are encouraged to provide this 
document to borrowers when you anticipate a substantial increase in 
bills paid out of the escrow account after the first year of the 
loan. Explanation of the reason for the increase is

[[Page 3238]]

recommended. The document may be delivered separately or combined 
with the Initial Escrow Account Statement. In the blank provided, 
insert the contact for further information, including the mailing 
address, fax number, e-mail address, and/or telephone number of the 
contact who will provide further information on making voluntary 
overpayments during the first year. The terms ``reserve'' or 
``impound'' may be substituted for the terms ``escrow account'' or 
``escrow'' to reflect local usage. These INSTRUCTIONS TO PREPARER 
should not appear on the form.]

[FR Doc. 98-1395 Filed 1-20-98; 8:45 am]
BILLING CODE 4210-27-P